PMS and Mutual Funds – A comparison worth making

By InCred March 10, 2021

The current financial landscape is ripe in terms of the wide range of products and services offered to individual investors. There are a plethora of investment products and vehicles currently available across the risk-return spectrum that can meet the varied needs of an individual.

As a result, sophisticated high-net worth individuals (HNIs) are eschewing cookie cutter solutions in favour of customised solutions that can add ‘alpha’ to their portfolio. This search for customised solutions and alpha has led several HNIs towards portfolio management services (PMS). Discretionary PMSs are those where the portfolio managers can exercise discretion with respect to managing the clients’ funds. In the case of non-discretionary PMS, the portfolio manager requires prior client consent.

PMS – Fast gaining currency

Over the last decade, the PMS assets under management (AUM) have witnessed exponential growth (as shown in the chart).

Source: https://www.sebi.gov.in/statistics/assets-managed/assets-managed.html

Why a PMS works for HNIs?

Opportunity to generate alpha – PMS providers invest directly in securities to create focused portfolios of high conviction ideas in an attempt to generate superior risk-adjusted returns. Most PMS portfolios hold 15 to 25 stocks while some can hold as little as 5 stocks. If the stock selection is done skilfully, then these concentrated portfolios can potentially deliver outperforming returns, especially in bull markets. In bear markets, concentrated portfolios also have the ability to underperform. Investors coming onto this platform should have the appetite to stomach some amount of excess volatility as compared to traditional mutual funds. Alpha stems from the fact that PMS portfolio managers are well positioned to capitalise on market opportunities due to relatively higher flexibility in terms of stock selection and minimal restrictions with respect to taking concentrated positions. Further, relatively smaller size also contributes to the agility of the fund manager and his ability to enter and exit a position with lower impact cost.

Transparency – Separate Demat accounts for every investor is maintained for PMS. Also investors get periodic reporting through statements by which they can monitor their portfolios. Additionally, investment in listed securities only introduces a higher level of disclosure and transparency to the clients’ investment portfolio. The Securities and Exchange Board of India (SEBI) has also prescribed a strict format of performance disclosure and clearly defined the rules around investment approach.

Flexibility : In the case of a Mutual Fund, SEBI restricts single stock allocation to 10%. MFs cannot cross the limit even if the fund manager finds the risk-reward attractive. This has resulted in most of the MFs being highly diversified. PMSs don’t have such restrictions, and this allows them to create portfolios based on their own risk assessment.

MFs also have restrictions on how much cash they can maintain in their portfolio. PMS managers don’t have these restrictions and can even be 100% in cash if they feel stock prices are too high.

An investment in PMS vs Mutual Funds (MF)

Factor

PMS

Investment exposure

Can be customised to reflect specific exposure

As per the investment mandate of the scheme

Portfolio composition

Concentrated

Generally diversified

Transparency

High – since the trade activity takes place in the client’s account. This information is received real- time

High – monthly factsheet contains all the necessary information regarding the trade activity during the month. However, this is received at the end of the month

Flexibility

Relatively high – the investment philosophy serves as a guide while the portfolio manager has the flexibility to invest or even maintain a 100% cash position

Relatively less – equity fund managers have to deploy a minimum of 65% of the scheme corpus

Account status

Each investor’s account is maintained independently and separately

Pooled account

Size of investment

Minimum amount of INR 50 lakh

Can start with an investment as small as INR 500

Fees

Combination of fixed management fees and profit sharing over a threshold rate. The normal range of the fixed management fees is 2-2.5%

Fixed and minimal

Taxation

Capital gains/loss to be taxed every time a stock is sold

Pass through status

PMS is an excellent product for the discerning investor who wants to generate alpha by investing in focused portfolios. However, it is best suited for those HNI investors who have the ability and willingness to better understand the nuances of equity investments and an inclination to be more involved in their investment portfolio.

PMS and Mutual Funds – A comparison worth making

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