PMS MF What's The Right Choice?

PMS MF What's The Right Choice?

In today’s times, investors are surrounded with a lot of investment opportunities and are in constant search of products that would provide them with the highest possible returns for either none or a negligible risk. However, this has also led to opportunities for fraudsters to create and sell fake products. Nevertheless, the capital market regulator, Securities and Exchange Board of India (SEBI), is trying to be one step ahead of them and curb any such malpractices that it may come across in the investment and advisory industry.

In this scenario, Portfolio Management Service (PMS) remains one of the most preferred investment avenues for high net worth individuals. To control fraudulent or mis-selling happening in PMS, SEBI has now issued guidelines for portfolio managers and also made certain amendments to the SEBI Registered Investment Adviser (RIA) regulation. The recent changes made with respect to PMS regulations have made us give a thought to how this will create an impact on the PMS and its investors.

Also, along with these changes it also makes sense to compare PMS with mutual funds. This is because most of the changes announced by SEBI make PMS akin to mutual funds. Mutual Fund PMS What’s The Right Choice? Nevertheless, the biggest difference between PMS and mutual funds would always be in the investment ticket size with the former requiring an initial investment of `50 lakhs or more. So, let us first understand what are the major changes that have been introduced and how can they can affect PMS, its intermediaries and investors.

Key Changes in PMS Regulations

SEBI has provided certain guidelines to portfolio managers that need to be followed by PMS, as detailed below:

1. No Upfront Commissions: No ‘upfront commission’ reminds you something? Yes! A similar thing was witnessed in the mutual funds’ space as well. Like PMS, even upfront commission of mutual funds was banned and all the intermediaries eligible to receive the commission were shifted to an ‘all trail’ model. This change had helped the mutual fund industry to somewhat reduce the mis-selling that was happening. Earlier, many intermediaries such as brokers were more concerned about the upfront commissions since the more they sold, more was the commission. Therefore, they sold products to customers irrespective of their needs or risk profile.

2. Operational Expenses: The operating expense, excludingbrokerage, that is charged over and above the fees for PMS must not exceed 0.50 per cent per annum of the client’s average daily Assets Under Management (AUM). These expenses are similar to the fund administration expenses that are charged by mutual funds.

3. Exit Load: Previously there were no restrictions on the exit loads charged by the PMS. However, most of the PMS have exit loads for withdrawals before one year with post one-year exit load being nil. To avoid the potential exploitation of investors, SEBI has defined the limits of exit load. For any withdrawal after one year of investment, maximum 3 per cent can be charged as exit load. If the investment age is two years then its withdrawal can be subject to exit load of maximum 2 per cent. For an investment amount with investment age of three years, maximum 1 per cent can be charged as exit load. For any investment ageing more than three years, no exit load can be charged.

4. Direct Plan: Like mutual funds, even PMS need to have ‘direct plan’. Direct plans are those that need to be directly purchased from the service provider without any agent in between. This change might attract a lot of High Networth Individuals (HNIs) that are investing in direct plans of mutual funds as they offer low-cost alternative to PMS. However, further in our story we would find out whether it really makes sense to have a direct plan option in PMS or not.

5. Performance: Performance reporting is something that can have a huge impact on PMS. Presently, there are no such rules for performance reporting to investors. Some of the PMS’ report performance to SEBI in one format and use another format for investors. Therefore, to have a standard performance reporting platform, SEBI has mandated to report performances net of all the fees and charges. Also, while calculating the performance, they would now need to consider all cash holdings and investments in liquid funds.

These were the major changes introduced by SEBI for the PMS industry, which will have far-reaching consequences on the PMS ecosystem, be it the product creators, intermediaries who are selling the product to end customers or investors who are buying this product. In the following paragraphs we will understand how these changes are going to impact different stakeholders.

Impact on Service Provider

In the short run, the inflows to the PMS would definitely get impacted. This is because majority of the inflows that they get are from distributors. With the upfront commissions gone, distributors have less incentive to sell PMS. To counter any slowdown in inflows, a PMS providing company needs to increase its reach by expanding the sales force, which would need its own sweet time.

Impact on Intermediaries Intermediaries

such as distributors and Independent Financial Advisers (IFAs) would get affected the most as they would not just have to forgo the upfront commission but also get affected by the introduction of the direct plan, which would mean that many of the informed clients will opt for the direct route instead of going through intermediaries, thereby leading to loss of potential clients. Only those distributors would not get much affected who have diversified their business across various products, right from mutual funds to PMS to AIF to insurance and even loans, real estate and Pear-to-Pear (P2P) lending.

Impact on Investors

The entire exercise has been done by the regulator to help investors and hence changes won’t have any negative impact on investors. These guidelines have been formed to protect the interests of the investors. In fact, the introduction of direct plans will only help investors to enhance their returns. The performance will be net of all fees and charges that would help them compare the true performance of PMS. Earlier, portfolio performance was shown to the investors, which may or may not be the actual returns that an investor might be getting. This is because he was paying fees and other charges from the returns.

After getting hang of the recent changes in the regulations of PMS and understanding how they are going to impact different participants, now it’s time to compare PMS with mutual funds. The most important aspect would be comparing their performance. Getting access to the performance and even any other data of PMS is very difficult. The information available in the public domain was till October 31, 2019. Therefore, we have taken the performance of mutual funds for a similar period. The performance of PMS and mutual funds is the average performance of the respective category. To have a level playing field, we have taken the performance of PMS net of its fees and charges. We have assumed PMS fees as follows.

Looking at the performance of PMS and mutual funds we can see that apart from one month i.e. the month of October 2019, in all the other trailing periods large-cap PMS was successful in beating large-cap mutual funds. Performance of the PMS is excluding the fees and other charges.

If we look at the performance of mid-cap and small-cap PMS and mid-cap and small-cap MFs separately, then MFs have outperformed PMS in almost all the trailing periods expect for the three-year period from November 1, 2016 to October 31, 2019. And in a five-year period the performance of PMS and MF is almost identical. This hints that if your investment view is long-term then PMS proves to be better than MFs.

Even in the multi-cap space, MF has outperformed PMS in almost all the trailing periods apart from the five-year period of November 1, 2014 to October 31, 2019. This again shows that in the long term PMS proves to be better than MFs even after accounting for all the fees and charges.

Comparing Direct Plans

With the new regulatory changes, like mutual funds, PMS also needs to have a direct plan. Therefore, it would be wise to compare the performance of direct plans of PMS with that of MFs. The distributor’s commission is the only difference between the expenses of regular plan and direct plan in case of PMS. Hence, to account for the same we have not considered the distributor’s commission while calculating the performance of PMS. However, other charges such as fund management fees are included.

The story even with direct plan remains the same for the large-cap category. Apart from the one-month performance, the direct plan of PMS outperformed the direct plan of MF for all the periods. Though in the long-term, PMS seems to slightly match the performance of MF.

Even in case of mid-cap and small-cap category, PMS with direct plan tends to underperform MF with direct plan.

Nevertheless, it does outperform in the long-term – three-year and five-year period. For multi-cap category, mutual funds with direct plan are able to beat the PMS with direct plan in all the periods except the five-year period. In the five-year period, PMS was successful in beating MFs.

Choosing the Right Product

After understanding the regulatory changes in PMS and accounting for the same while comparing its performance with MFs, it is important to understand which product is for whom. We all know that no investment avenue is bad; it’s just that everyone has different investment objectives and thus needs different investment options. Therefore, it won’t be right to compare investment avenues. Only it is important to understand each product’s suitability to different types of investors. There are various ways to understand product suitability. You can get your risk profile accessed and understand your financial goals and investment objectives, minimum investment amount, etc.

Even if we see that in some instances PMS was able to beat the MF, not everyone can invest in PMS. First of all, the ticket size of PMS is Rs50 lakhs. Previously the same was Rs25 lakhs. Secondly, PMS being a concentrated portfolio, it adopts various strategies to maximise returns and comes with a lot of risk. Therefore, it is preferable for HNI and ultra-HNI investors as they have big ticket size and also they tend to be aggressive investors with higher risk appetite. On the contrary, mutual fund is for all: it caters to conservative as well as aggressive investors. The minimum investment amount is also low.

Even if an investor is unable to invest a lump sum amount, he has an option to invest gradually through a Systematic Investment Plan (SIP) which is not available in case of PMS. SIPs have proved to be one of the most disciplined ways of investing and you don’t need to time the market for that. Therefore, investors who have done their financial planning and worked out their financial goals can opt for PMS. This will help them to generate wealth. For others, mutual fund would be an appropriate product.

Conclusion

The recent regulatory changes affect the performance of PMS as against MF. From an investor’s perspective, it has increased its attractiveness as performance is likely to improve. Nevertheless, it will also depend upon the investment of PMS in liquid and its cash component. If they form a larger share of corpus (chances of which are very less) these changes might impact their performance. Definitely the performance of PMS would deteriorate in terms of presentation as now it would need to deduct all the fees and charges from gross performance. Besides, inclusion of cash and liquid funds while calculating the performance of PMS will also have an impact on their performance.

Product suitability is another thing an investor needs to consider. Both PMS and MF cater to different sets of people. If you are an aggressive risk taker and have the ability to invest a minimum of Rs50 lakhs, you could consider investing in PMS. For the rest of investors, it is better to invest in mutual funds. Also, when investing in mutual funds ensure that proper asset allocation is in place and also link your mutual fund investments to your specific investment objectives. Even those who can afford the ticket size of Rs50 lakhs should consider investing in PMS only if their financial needs are taken care of.

 

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