PMS often better than direct equity investment

However, a mutual fund usually scores over a portfolio management service in transparency, cost and taxation

The assets under management (AUM) of portfolio management services (PMS) have seen an uptick with the market’s rise. The AUM for discretionary PMS rose to ~67,300 crore as on end-April from ~45,584 crore a year before, show data from the Securities and Exchange Board of India (Sebi).

With the market experiencing volatility, PMS could be a better option than direct investment for savvy high net worth individuals (HNIs). “Data suggests 90 per cent of direct equity portfolios have been beaten by PMS and mutual fund (MF) investments. A managed portfolio is always better than direct equity investment,” says Feroze Azeez, executive director and head of investment products, Anand Rathi Private Wealth Management.

PMS allow investors to customise portfolios, depending on risk appetite and returns expectation. “PMS is the next step for those who have already dabbled in direct investment and MFs,” says Sameer Kamdar, former managing director of ASK Investment Managers.

PMS vs MFs

PMS run a more concentrated portfolio of 15-20 stocks compared with equity schemes of MFs, which generally invest in 40-60 stocks. A concentrated portfolio increases the potential of higher returns but adds to the risks. “The standard deviation in PMS portfolios are at least 60-70 per cent higher than MF portfolios because of the higher concentration,” says Azeez.

Equity MFs charge between 2.5 per cent and 3.25 per cent in expense ratios. In PMS, fixed fees vary at 1-2.5 per cent but there might be a variable component as well, on a profit-sharing basis. “Globally, most investments by HNIs are on a profit-sharing basis. In India, most customers prefer to pay a larger fixed fee and either a no-profit share or small profit share of 10-15 per cent,” says Kamdar.

Experts suggest a low initial fee of, say, one per cent, with a profit share component might seem cheaper but prove far more expensive than an MF, especially in a bull market. “In a rising market, investors run the risk of surrendering a larger chunk of the alpha generated to the fund manager as fees,” says Azeez.

Let’s say the PMS doubles your money in a period when the Nifty clocks 83 per cent gain. This means the fund manager has generated an alpha of 17 per cent. However, if the investor has entered into a 15 per cent profit sharing arrangement, the investor will have to surrender most of the alpha (15 per cent) to the fund manager.

PMS is more tax-inefficient than an MF. Every time a PMS fund manager buys and sells, the client has to pay short-term or long-term capital gains, as the stocks are directly credited or debited from the investor’s account. If stocks are repeatedly bought or sold before completing a year, the tax authorities can deem it to be business income and tax gains at 30 per cent. Similarly, clients might not be able to write off fees paid to the fund manager as expenses. These problems don’t arise in equity MFs, as investments are pooled.

A PMS can give better fund manager access than an MF, provided you invest at least ~5-10 crore. This access can help investors understand the logic of stock picks. However, most of the competent fund managers are employed by MFs, as they have a larger asset base. “The talent asymmetry means it is difficult for PMS fund managers to reach out to company managements and broking houses for research,” says A V Srikanth, chief executive at Citadelle Asset Advisors.

MFs score over PMS in transparency. “To showcase the portfolio performance, PMS providers often depict unaudited performance numbers and compare it with benchmarks. These numbers might be unreliable, as they are not generated by independent accountants, as in the case of MFs,” adds Srikanth.

Most of the competent fund managers are employed by MFs. The talent shortage makes it difficult for PMS fund managers to reach out to company management for research

Reality check

While PMS is supposed to provide a differentiated offering, the reality is that most PMS’ provide only a few model portfolios that clients can choose from, unless the investment amount is significantly large, say experts.

Stability of the fund manager, performance, fee structure and transparency are some factors to look at before investing. The lower the portfolio turnover, the better; it will minimise tax outgo. “Since PMS portfolios are concentrated, investors should find out about the portfolio mandate, stock/sectoral caps and risk-mitigating strategies to protect the downside,” says Kamdar.