Portfolio Management and Mutual Fund Industry

Portfolio management services (PMS) and mutual funds (MF) are avenues to invest in stocks or bonds. Even though both of them are indirect ways of investing in the markets, there is a lot of difference between the two.

Let’s understand the dynamics of these investment avenues and factors to be considered before investing in the same….

Portfolio Management Services (PMS)

PMS is a type of wealth management service that offers a range of specialized investment strategies to benefit from the opportunities in the market, and is managed by professional portfolio managers.

There are two types of portfolio management services (PMS):
• Discretionary PMS

• Non-discretionary PMS

In discretionary portfolio management, the portfolio manager individually and independently manages the funds of each client. But in non-discretionary portfolio management, the portfolio manager manages the funds in accordance with the directions of the client. The portfolio manager cannot make buy-sell decisions at his own discretion; he has to refer to the client for every transaction.

Mutual Funds (MF)

A mutual fund is a professionally-managed investment scheme, run by an asset management company (AMC) that pools together a group of people and invests their money in instruments/assets for a common investment objective.

As compared to PMS, MFs have a wider range of investment options, that an investor can invest in based on his risk profile.

Now let us understand which investment is more suitable – PMS or Mutual Funds?

1. Transparency and Regulations: Mutual funds are more transparent as compared to PMS as they are tightly regulated by SEBI whereas PMS are not very transparent in their disclosures.
2. Minimum Investments: PMS is typically a high-end product meant for high net-worth individuals (HNIs) because the ticket size is very high (minimum investment of Rs 25 lakh). In mutual fund minimum investment starts from Rs 500. Hence, mutual funds cater to a much wider investor universe.
3. Fees & Charges: As compared to mutual funds, PMS charges a very high fee for management of portfolio. It charges various kinds of charges and fees such as:

Entry Load: An entry load is usually charged at the time of buying the PMS.

Fund Management Charges: Every PMS scheme charges fund management charges, which is variable in nature as per the PMS Provider.

Profit Sharing: Some PMS schemes also have profit sharing arrangements, wherein the provider charges a certain amount of fees or profit over the stipulated return generated in the fund. There is no profit sharing in MF. Once the fund management charge is paid, all the appreciation is owned by investors.

Fixed Fee: Some PMS schemes might have a fixed component in the place of the profit sharing component and charge investors a fixed monthly fee. This is not a percentage based fee and is decided before investing in the PMS. It could depend on the size of the portfolio.

MF on the other hand, have a minimal expense ratio and exit load (up to a certain period). Hence, MF are more cost effective than PMS.

4. Risk: MF offer various options and diversification, suitable for investors with different risk appetites. For instance, a risk-taking investor can opt to invest in an aggressive equity fund whereas a risk neutral or risk averse investor can invest in balanced or other less risky funds. In comparison to MF, PMS investments are riskier as these products usually hold a very concentrated portfolio of 20-30 stocks. Investing in a concentrated portfolio can be very risky as compared to well diversified mutual funds. Generally, MF invests in more number of stocks (varies from fund to fund) compared to PMS.

Further, SEBI has imposed restrictions on MFs which take positions in derivative instruments. However, PMS do not have any such restrictions, they are actively managed and take considerably higher risky positions which could provide huge upsides; however, if it goes wrong, the portfolio could drag down considerably.

5. Consistency: It is a common belief that PMS always generates superlative returns as compared to mutual funds. However, if we look at historical performance, mutual funds have given high returns in a consistent manner, over the years.
6. Complexity: While evaluating the performance of a PMS, a retail investor will have limited access to data and also it is much more complex. Mutual funds, on other hand are simple to understand and all the information about the fund is easily available on the AMC’s website from time to time.
7. Liquidity: Since, PMS generally have a lock-in period and high exit charges, it is illiquid compared to mutual funds. Mutual funds can be liquidated (unless it is close ended and has a lock in) very easily at very less exit load applicable, if any.
8. Taxability: When an individual invests in mutual funds, he is allotted units. On redemption, units redeemed are subject to long term/ short term capital gains tax based on the holding period. In between, any transactions related to buy/sell of shares by the fund manager does not attract any tax for the investor.

Whereas In PMS capital gains are computed on each underlying transaction done by the fund manager. In the structure of PMS, all the stock holdings are directly in the name of investor (not units of a scheme). So, every time the portfolio manager sells a share, there is an incidence of capital gain/loss for the individual investor. If the share is held for less than 12 months, short term capital gains will be taxed @ 15 percent.

To conclude tax implication in mutual funds for an investor is only when he is exiting the fund. In PMS, there may be tax implication even while you are still invested in the same.

9. Dependency: PMS are more prone to psychological biases of the portfolio manager. Most of the investment decisions taken in PMS depends mainly on the portfolio manager’s judgement. This is because the portfolio holding is more concentrated, hence there is a lot of dependence on the fund manager’s stock picking ability. In mutual funds, fund manager takes investment decisions which are more process oriented and risk mitigated. Even though some PMS do have processes is place, the one’s followed by mutual funds are much more transparent and tightly regulated, in comparison.

PMS v/s Mutual Funds at a glanc

Considering the underlying investment for PMS and diversified mutual funds is similar it doesn’t make any sense to invest in PMS and structured products, which are closed-ended, less transparent, tax inefficient and charge a higher fee.

PMS in India is still in its nascent stages and has a long way to go. Hence, we believe that mutual funds remain one of the most suited ways of investing in the markets.