When you have a substantial investment portfolio, what makes more sense? Going with a PMS or sticking to some good mutual funds? Let’s answer this question.
Many are familiar with mutual fund schemes offered by Asset Management Companies (AMCs). Interestingly, AMCs also offer Portfolio Management Services (PMS) for high net worth individuals along with brokerage firms and independent portfolio managers. Like mutual funds, their offerings are customized to suit your understanding of risk.
Should you choose PMS over the regular mutual fund schemes?
First of all, let’s understand PMS.
PMS is an investment service offered by a portfolio manager whereby its investors get the flexibility to tailor a portfolio, according to personal preferences and their financial goals. When they invest in PMS, investors actually own shares or bonds in their name as against a mutual fund investor who owns units of a mutual fund scheme.
Usually, there are two types of PMS products – discretionary and non-discretionary. In case of discretionary PMS, the portfolio manager chooses stocks and bonds as well as the timing of its buying based on his discretion (and hence the name). The majority of the PMS in India are of this type and are tilted towards managing equity-based portfolios. Under non-discretionary PMS, the portfolio manager only suggests the investment ideas to the investor. Once the investor gives approval, the portfolio manager executes the trade on his behalf.
One needs to evaluate the following parameters before deciding to go for a PMS:
1. Minimum portfolio size
PMS has got to have a minimum portfolio size of Rs 50 lakh, as per Sebi regulations. However, some portfolio managers might set a higher threshold. As an investor, obviously, you wouldn’t want to put all eggs in one basket and therefore diversify your investments across three to four PMS providers. So, your portfolio size needs to be about Rs 2 crore (assuming you invest Rs 50 lakh in four PMS providers) to justify investing in a PMS. In contrast, you can start in mutual funds as low as Rs 500.
2. Cost element
PMS providers usually charge between 2%-3% of the portfolio annually and it is usually a function of the portfolio size. Bigger the portfolio, the lesser the costs. Besides, there are also incentive-based charges that add to overall costs. For instance, the portfolio manager might charge 15% of profits made in excess of Rs 50 lakh. Or it might be linked to ‘excess’ returns over a pre-agreed threshold. Also, there could be extra charges in the form of audit fees, brokerage charges, stamp duty, custodian, Demat, and so on.
The quality of data in the public domain is not convincing to evaluate the performance of portfolio managers. First of all, we have data for a limited period of time (only since Jan 2013) that hardly covers multiple market cycles.
As per Sebi regulations, equity funds are permitted to charge a maximum of 2.25% every year as annual expenses (all-inclusive) while it is 2% for debt funds. If one considers all the above costs of PMS, many are today charging investors on the higher side as compared to that mutual funds.
3. Track record
The quality of data in the public domain is not convincing to evaluate the performance of portfolio managers. First of all, we have data for a limited period of time (only since Jan 2013) that hardly covers multiple market cycles. Moreover, the data of performance shared by PMS portfolio managers might not be the aggregate returns of all their investors and perhaps only that of its ‘model’ portfolio.
Unlike mutual funds, where the track record of all schemes is publicly available and well-researched, it is not so the case with PMS. While there are some with a superlative track record, it is important to do the necessary due diligence.
4. Tax implication
Selling an equity-oriented fund after a year attracts long-term capital gains tax of 10% for its investor. However, its fund manager can sell and buy stocks many times over without any tax implication whatsoever for its investors. In contrast, for a PMS, any sale or purchase of stocks in the portfolio attracts taxes for its investors, since it is directly owned by them.
Mutual fund regulations have lots of checks in place to protect the portfolios of retail investors. For instance, a single stock cannot be more than 10% of an equity fund portfolio. However, a PMS portfolio manager can create a concentrated portfolio by investing disproportionate amounts in favor of compelling opportunities. Similarly, the portfolio manager can go 100% cash, if they feel the market is overheated and weak.
While PMS gives the flexibility to portfolio managers in investing and also an opportunity for investors to benefit from tailor-made investment advice, it is also fraught with risk.
PMS is not for all. You need a substantial portfolio to invest in PMS. With quality data in the public domain as regards its track record, most investors are better off choosing schemes from the well-regulated mutual fund industry.