MF Vs PMS Vs AIF

The financialisation of savings has led to the emergence of various financial products in the investment space. analyses the three most prominent among them DSIJ and elucidates their differences and their suitability to different types of investors.




Indian economy is at the cusp of change and is witnessing a rapid expansion in various sectors of the economy. The financial sector has not remained immune to this and is seeing strong growth in the financial services firms. To diversify their offerings and tap a niche clientele, mutual fund houses too had started offering new set of financial services known as Alternative Investment Funds (AIFs) and Portfolio Management Services (PMS).

These were the services that were being earlier offered by various other financial companies. Nevertheless, the market regulator Securities & Exchange Board of India (SEBI) has now allowed asset management companies (AMCs) to offer these services.

These financial services, be it MF, PMS or AIF, all seek to invest on behalf of the investors and generate better returns for them. As an investor, it will be confusing for him to choose between the services as all try to maximize returns on their investments. The situation becomes even more puzzling as, many a time, all these services are being offered by the same institution.

Nonetheless, these financial products have more differences than similarities. In this story, we will try to find which product is meant for whom and who can opt for these financial products.

Mutual Funds

SEBI defines mutual fund as a fund established in the form of a trust by a sponsor to raise monies by the trustees through the sale of units to the public under one or more schemes for investing in securities in accordance with these regulations. Simply put, mutual fund is a trust that pools money from the public and invests it as per its investment objectives.

Therefore, mutual fund investments are meant for every type of investor. One can start investing in mutual fund schemes with as low as Rs 100 and someone with an investment corpus of Rs 1 crore can also invest in mutual funds. Mutual fund offers wide variety of investment avenues that can be used by all types of investors.

One of the unique features of MFs that suit a small-time investor is systematic investment plan (SIP), which allows them to invest their savings into MF schemes every month. Besides, there are certain categories of MF schemes that provide tax rebate to the investors.

Portfolio Management Services


The next in line in terms of sophistication of financial products is the Portfolio Management Service (PMS). It is an investment portfolio of stocks, debt and fixed income securities which are managed by a professional fund manager, often known as portfolio manager. When you are investing in PMS, you hold each security unlike mutual funds, where you would only own units of the entire portfolio.

PMS requires higher ticket size of investment (the minimum investment amount is Rs 25 lakh) compared to mutual fund and have more concentrated portfolios, which makes PMS more risky compared to MF. Hence, the PMS is more suited to a mature investor who understands the market and its dynamics. It is mostly used by the high net-worth individuals (HNIs) to invest primarily in stocks (but not necessarily only in stocks) with the help of portfolio managers.

There are primarily two types of PMS—discretionary and non-discretionary. In the case of the discretionary option, the portfolio manager at his own discretion makes investment decisions on your behalf and does not need to consult you for every transaction. Nevertheless, if you want you can always share a negative list of securities with your fund manager where you do not want to invest. The portfolio manager will take into consideration this list before constructing your portfolio. The discretionary variant of PMS is more widespread in the market.

In the case of non-discretionary PMS, your fund manager will consult you before making any investment on your behalf. You have full control on your portfolio. This is less prevalent in the market.

PMS investment is definitely advisable for investors with deep pockets as it requires large investment amount. Nonetheless, they can even take mutual fund route if any of the mutual fund categories or funds serve his investment objectives. Since PMS can also be customised, it can also be used by investors to fulfil any particular financial objective.

The drawback or the risk involved with the PMS is that it is more like focused mutual funds with large exposure to mid-cap and small-cap stocks, which makes it a risky option. Moreover, PMS has lower regulation and governance compared to mutual funds. Therefore, PMS is less suited to retail investors.

The returns generated by the PMS cannot be generalised and compared as it will depend on the category (such as market cap wise) and strategy adopted by the portfolio manager to manage the fund, which in many cases are not the same.

However, even comparing the performance of the PMS with respective category, we find wide fluctuation in the performance. For example, in the multi-cap category, the performance in the last one year varies from negative 6 per cent to 23 per cent. Compare this with mutual fund, where the average return of multi-cap funds was 0.95 per cent in the same period and range of return was between negative 22 per cent to positive 7.32 per cent.

The above figure should be taken with a pinch of salt as these results are point to point comparison and that too of a single period. Moreover, since the market has run up in last three month ending April 2019, higher beta and concentrated portfolios had done well. Had the comparison been done in the month of January 2019 the story would have been different. 

Alternative Investment Fund

Alternative Investment Funds or AIFs are very new to the investment space in India. They have been formalised only six years ago. Nonetheless, the rise in their AUMs shows their higher acceptance amongst investors. In just a few years of their existence, these have grown at an astounding pace of 102 per cent annually and AUMs have touched Rs 1.34 lakh crore at the end of FY19. This means that every year, the AUMs of AIFs has been doubling.

The capital market regulator has divided the AIFs into three categories. The category I AIF includes angel investors, venture capital, social and infrastructure funds; category II includes private equity, real estate, distressed funds and any AIFs that are not covered under category I and category III. The category III includes funds with diverse trading strategies, hedge funds or ones with an eye on short-term returns. Unlike the first two categories of AIFs, the third type of funds can be open-ended in nature.

Among all the three categories of AIFs, it is category II that has the highest AUMs and corners around 62 per cent of the total AUMs. Nonetheless, in terms of annual growth, it is the category III that has witnessed the highest growth of 123 per cent annually. The reason for such an increase can be attributed to some of the advantages offered by the category III funds.

According to industry experts, category III AIFs in the current volatile market conditions can generate returns that are not fully linked to capital market movements and they allow a different risk-return trade-off to be created. Besides, these funds can also pursue a long-short strategy, access multimanagers or take advantage of a drawdown structure, which allows investors to invest in a staggered manner and try to time the market.

AIF has a clear advantage over the PMS and mutual fund as it allows hedging strategies that may limit your fall in an adverse market condition. In the case of PMS and mutual fund, you can hedge, but for this, you need to be financial wizard and do it yourself.

The returns generated by the AIF will depend primarily upon the manager’s skills, especially in the case of category III. In the case 





What are different types of MFs, PMS and AIF?

Mutual Funds

After the re-categorization done by the SEBI, mutual funds are divided into 5 major categories as explained below:

Equity Schemes : Equity schemes are those which predominantly invests in equity and equity-related instruments. SEBI has even further categorised equity schemes into 10 sub-categories, viz. multi-cap funds, largecap funds, large and mid-cap funds, mid-cap funds, small-cap funds, dividend yield funds, value funds, contra funds, focused funds, sectoral funds, thematic funds and ELSS. All these sub-categories have different investment principles as mandated by SEBI with minimum and maximum proportions defined.

Debt Schemes: Debt schemes are those which predominantly invests in debt and money market securities or instruments. SEBI has even further categorised debt schemes into 15 sub-categories viz. overnight fund, liquid fund, ultra-short duration fund, low duration fund, money market fund, short duration fund, medium duration fund, medium to long duration fund, long duration fund, dynamic bond fund, corporate bond fund, banking and PSU debt fund, gilt fund, gilt fund with 10-year constant duration and floater fund. These are sub-categorised based on their Macaulay duration and credit ratings.

Hybrid Schemes: Hybrid schemes are those which invests in  multiple asset classes in various proportions. However, the major asset classes they invest in are debt and equities. SEBI has even further categorised equity hybrid schemes into 7 sub-categories, viz. conservative hybrid funds, balanced hybrid funds, aggressive hybrid funds, dynamic asset allocation also known as balanced advantage funds, multiasset allocation funds, arbitrage funds and equity savings funds. These are sub-categorised by SEBI based on asset allocation proportions and assets involved. SEBI has even defined the proportions.

Solution-oriented schemes : These schemes are specifically designed for a particular goal. Currently, it is dedicated towards retirement and children. SEBI has sub-categorised this schemes into two, viz. retirement funds and children’s funds. SEBI has also defined a lock-in period for both categories of funds.

Other schemes :These schemes are those which do not fit into any of the above major categories as defined by the SEBI. 

These funds are further sub-categorised into two, viz. index funds or ETFs (Exchange Traded Funds) and FOFs (Fund of Funds) - domestic/overseas.

PMS

PMS have majorly two types, viz. discretionary and non-discretionary. These are segregated based on the decision-making power of the fund manager.


Discretionary PMS : 

This is very much like a mutual fund wherein a portfolio manager manages your portfolio on your behalf and takes all the decisions himself without consulting you. He can buy and sell securities at his own discretion and does not need your permission to execute the same.

Non-discretionary PMS : 

This is the opposite of discretionary PMS, wherein the portfolio manager needs to consult the investor before taking any decision. He cannot buy or sell securities unless the investor permits him to do so.

AIF

SEBI has divided AIFs into three major categories.

Category I AIFs : 

These AIFs invest in start-ups or early stage ventures or social ventures or SMEs or infrastructure or other sectors or areas which the government or regulators consider as socially or economically desirable and includes venture capital funds, SME funds, social venture funds, infrastructure funds and such other alternative investment funds as may be specified.

Category II AIFs:

These AIFs do not fall in category I or category III and do not undertake leverage or borrowing other than to meet day-to-day operational requirements and as permitted by the SEBI (Alternative Investment Funds) Regulations, 2012. Various types of funds such as real estate funds, PE (private equity) funds, funds for distressed assets, etc. are registered as category II AIFs.

Category III AIFs :

These AIFs employ diverse or complex trading strategies and may employ leverage, including through investment in listed or unlisted derivatives. Various types of funds such as hedge funds, PIPE funds, etc. are registered as category III AIFs.

of category I and category II, it is hard to estimate the return as they are closed-ended and are not available for the public.

In case of category III, and that too for the hedge funds, there are some data available, which shows that Indian hedge funds have generated return better than their global counterparts and frontline equity indices such as Nifty and Sensex. Although AIFs have provided better returns, they are not meant for retail investors. AIF is advisable for a sophisticated investor who is more interested in growth of his wealth and not looking to meet any financial objectives.

The Market Returns and AUM Growth

After understanding MFs, PMS and AIFs, now let see how these have grown over the years and their relation to overall market growth. We have taken BSE 500 as proxy for equity market. 



Since FY15, the domestic AUMs of mutual fund industry has grown at an annualised rate of 17%, while that of PMS and AIFs, the AUMs have grown at CAGR of 11% and 70%, respectively. One of the reasons for higher growth of AIFs is because of large ticket size of minimum investment and better returns provided by them, irrespective of capital market condition. This is clearly visible in the table above.

If we look at the data above, we can say that when the market falls, people tend to get conservative and shift their funds to other assets such as bank FDs, real estate, gold, etc. Hence, there is fall in the growth of investment in MFs and PMS. However, in the case of AIFs, we see they continue to grow, irrespective of market movements.

How all three fare on costs?

Before deciding which is better for you, you should also understand the cost involved or fees charged by these financial products to make sound investment decision.

When it comes to costs, mutual funds cost the least among the three and AIF is the costliest product. Let us compare the fees they charge to investors directly or indirectly.



If we look at the above table, then indeed mutual funds seem to be the product costing less than the others. For comparison purpose, we have assumed MFs as equity mutual funds. The upfront commission charged by the AIF makes them a costly product. In the case of AIFs, the distributor earns much more than in the case of PMS and MFs.

In case of MFs, the cost is regulated by the SEBI and kept within a ceiling of 2.5 per cent, but in the case of PMS and AIFs, the same does not hold true as there is no such ceiling provided by the regulator as of now. However, the cost should not be the issue, as all three of them operate and function differently, with even their target audience being different. So, the cost should not be the only criteria while making an investment decision.

How much risk is involved?

As far as risk is concerned, MFs carry lower risk as compared to PMS and AIF. AIF is the riskiest. This is because of the fact that AIF invests in venture capital funds, SME funds, social venture funds, infrastructure funds, real estate funds, private equity funds (PE funds), funds for distressed assets, etc. which makes investment in AIF a risky proposition. This might be the reason why SEBI in its definition has stated that AIF is only for ‘sophisticated investors’ and even the minimum investment amount is Rs. 1 crore. On the risk front, PMS sits in the middle.

Conclusion

So, which investment product should you go for, mutual funds, PMS or AIF? This would depend on various factors. First is your investment corpus. If your investment amount is less than Rs. 25 lakh, then mutual funds are best suited for you. If your investment amount is less than Rs 1 crore, then you can opt for PMS, depending on your risk profile. Anyone having investment amount more than Rs one crore can definitely go for AIFs.

The second biggest thing to consider is risk. If your risk appetite is low to medium, then mutual funds are good to go with. However, if your risk profile is medium to high, then PMS can also be an option, apart from mutual funds. But to invest in AIF, you need high risk appetite.

Even liquidity can also play a deciding factor. If your requirement demands liquidity, then investment in mutual funds and PMS would be a better option for you. In certain cases, AIF category III also offers some opportunity. If you can invest Rs 1 crore or more with a long term time horizon and high risk appetite and your only goal is to create wealth, then AIF would be a better option to go with.

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