PMS Versus Investment Advisory : Which Is Better?

There are various ways in which an investor can participate in the equity markets. Portfolio management service or PMS is emerging as one of the most promising ways to participate in the markets for high net-worth individuals (HNIs). But is PMS the best way to beat benchmark indices or is hiring a decent investment advisory service (IAS) good enough to beat benchmark indices? Ganesh Vaybase explores the pros and cons of PMS versus IAS while also exploring the benefits of mutual fund investing

Portfolio management service (PMS) has come a long way in India. Almost 77 per cent of the PMS’ have been able to beat Nifty in September even as Nifty delivered negative returns in the same month, if we were to believe the data published by PMS Bazaar. Some of the PMS’ have even gone on to generate returns up to 14 per cent in September when the Nifty struggled. Large-caps have underperformed in September and hence those strategies that were skewed towards broader markets were seen outperforming.

Such a superlative performance of PMS’ in the short term attracts attention no doubt. However, one has to understand the overall trend in the wealth management industry in India to understand the growth curve of the PMS industry. India is consistently ranked amongst the top ten nations in terms of expected growth in the wealth management industry. The industry is expected to clock higher double-digit growth and is truly one of the fastest growing markets globally.

Rising GDP, favourable demographics and lower penetration are some of the key factors proving to be the growth drivers for the wealth management industry in India. Wealth management is a broad industry and the PMS industry is a small sub-set of the wealth management industry, which promises to grow steadily as stock markets continue to impress investors in spite of the current pandemic. In fact the current pandemic has acted as a boon to the industry and has revived the risk appetite of several investors.

A PMS account is nothing but a sophisticated investment vehicle where the portfolio manager invests in stocks and other financial instruments on behalf of the clients taking into consideration the risk profile and the investment objectives of the investor. Take into account here the Securities and Exchange Board of India (Portfolio Managers) Regulations, 1993 issued by the regulatory body on January 7, 1993. This initiative marked the beginning of PMS as a formal investment vehicle in India. Parag Parikh Financial Advisory Services Ltd. (PPFAS) was one of the first of the companies to launch a PMS named Cognito in October 1996 while ICICI Prudential was the one of the first institutional participant to provide PMS services.

As the markets began to shine, the numbers of PMS providers kept growing and a major fillip to the PMS industry was provided by the rising equity prices in 2004 to 2008. The number of PMS providers mushroomed during the bull run of 2004 to 2008 and the number dipped as the markets witnessed a sharp dip due to the global financial crisis (GFC). As of now, there are various PMS providers and hundreds of different PMS schemes available for investors. Each one has a unique strategy that promises to beat the benchmark indices year after year.

Broadly speaking, the PMS’ can be differentiated based on their focus i.e. multi-caps, small-caps, mid-caps and large-caps. There are various PMS’ which call themselves by catchy names viz., Deep Value, Build to Last, Legend, Marvel, etc. depending on their conviction and market-beating strategy. But primarily all of the PMS’ can be categorised by the capitalisation they focus on, just as in the case of mutual fund schemes. The year 2020 has been excellent for the industry with several PMS’ providing market-beating returns. The table below highlights the performances of some of the top performing PMS’ in 2020.

While several PMS’ have have been impressive with their performance in 2020, the same cannot be said if we take a three to five years’ view. Most of the PMS schemes have struggled to beat the Sensex returns over the longer horizon. The returns generated by some of the most popular PMS’ over a 10-year period are comparable with the mutual funds’ performance. It is noticed that the top performing PMS’ have managed to deliver returns in the range of 12-16 per cent (annualised) while similar returns can be observed in some of the top performing mutual funds with a track record of over 10 years.

 

Advantages of PMS

While PMS’ are getting popular as overall wealth appreciates amongst the HNIs, there are certain clear advantages that PMS’ have over other methods of participation in the equity markets. PMS is often compared with mutual funds. The fixed cost component is lower when compared to the mutual funds; however, it can be substantially higher when compared to investment advisory services. When the ticket size is large enough the lower fixed costs proves to be an advantage.

Often the portfolio managers propose a profit-sharing formula with clients over and above the hurdle rate. So there is an incentive to generate higher returns. Many investors are willing to share the profits in pursuit of higher ‘take home’ profits from the investments. This is one of the unique features of PMS’ not available either with mutual funds or with the investment advisory services. One of the most interesting aspects of PMS is the ability to connect with the portfolio managers. Practically it may not be possible for the portfolio manager to discuss with each and every investor but there is a good chance that the investor will be able to satisfy his or her market and portfoliorelated queries from the expert.

Again, this may not be possible in case of large-sized equity advisory services and mutual funds even though there could be certain exceptions in case of equity advisors as some equity advisors do offer premium services where the clients can interact directly with the analyst or the portfolio advisor. Says Alok Munot, an HNI investor who is a doctor by profession: “I started investing in 2004 and initially I use to invest on my own, buying randomly stocks that I thought would give good returns. I made good profits and I realised that my portfolio size had increased a lot. So, I started taking risks and even indulged in short-term trading.” 

“But I lost my focus and starting booking losses which disturbed me. This adventure in the stock market also started affecting my profession and I struggled to concentrate on my practice. Following the advice of a colleague I opted for PMS from a reputed AMC. Since then I don’t have any worries and my wealth has been growing steadily. The returns are not extraordinary but they are market-beating returns. The thing I realised is when the portfolio size grows it is not easy to handle the market volatility and risk. It is best left to professionals,” he adds. “It’s one thing to manage your own portfolio of let’s say Rs 25 lakhs but when the portfolio size is more than Rs 3 crore, risk portfolio management has to be sophisticated. I lacked such sophistication and hence opted for a PMS,” he further shares. Indeed, PMS’ can provide sophisticated risk management and portfolio diversification just like mutual funds without compromising on the targeted aggressive returns. PMS can construct a focused approach and bet on a few conviction stocks, thus offering potential for higher than average returns. 

INTERVIEW 

Apoorva Vora, Founder and CEO, Finolutions 

Between equity advisors and PMS providers, which are the important aspects that investors should consider? 

While both would have equities as their underlying, there are big differences in approach and process. PMS is slightly more regulated as compared to equity advisory, though both require SEBI approvals. PMS has a minimum investment size of Rs 50 lakhs, which makes it a product viable only for a larger investor who can allocate such sums to a manager. On the other hand, equity advisory as a service can be availed for a lot lesser investment commitment. This means size can be one consideration for an investor.

PMS being slightly more regulated, it is easy to evaluate as there are performance data available through various means. The data is also reported on the SEBI website. Equity advisory on the other hand is a more discrete service between the advisor and the investor and little is available in the open domain. However, such a service may provide for a higher level of customisation as compared to PMS. One must realise that both the products are not substitutes of each other. One is meant for a slightly more evolved and larger investor while the other product is largely meant for a retail investor looking at a substitute of his direct equity investment desire. 

Further, PMS offers discretionary services and therefore does not require investor approval for each and every trade as it is operated with a power of attorney where the portfolio manager uses his discretion to build the portfolio. Equity advisory on the other hand will require consent from an investor for every trade, which makes it operationally challenging for an investor who is pressed for time. To summarise, both PMS as well as IAS are aimed at managing equity on behalf of an investor. It’s just that they are operationally different, meant for slightly different target audiences, and therefore have slightly different skill-set requirements for the managers. An investor should ideally consult his advisor on the selection of either of the products and their rationale. 

How to choose a good equity advisor?

Following are the points to keep in mind while selecting a good equity advisory firm:

✓  One may have a preference of an equity advisor who has a PMS management background or a hardcore equity research house background. This is often the first filter an investor may have.
✓ The objective of the equity advisor should be to build a longterm well-researched portfolio and not to excessively churn portfolios for making broking gains.
✓ Research team strength and quality is very critical. An investor must check on this aspect before taking any decision about an equity advisory partner.
✓ An investor should also check on the ability of the equity advisor to be able to service a larger client network. This bandwidth check is critical in the long run.
✓ Lastly, but importantly, the underlying advisory should be completely aligned with the risk profile of the investor. Only then it becomes a meaningful diversification.

How can you choose a good PMS?

A very common mistake investors make is looking at the past performances, including across timeframes. That cannot or should not be the only criteria for PMS selection. There are a lot of other factors that go in selecting a right PMS partner. One needs to consider the following points while choosing a good PMS:

✓ Continuity of the portfolio manager: We have often seen that portfolio manager change leads to change of fortunes for a PMS strategy. Some investors have a stronger preference for a founder-led or run PMS for the very same reason.
✓ Uniqueness of the theme: Investors do not want to replicate a style available in the equity mutual funds with an overlay of a PMS. Most investors prefer to have a PMS that offers a differentiated theme or risk profile to suit an investor’s overall portfolio.
✓ Performance across timeframes, and more importantly across various phases of the market, is also an important factor but not the sole factor. The ability and willingness to keep the portfolio aligned to the market dynamics is an important factor. This is required at least from a strategic viewpoint and not necessarily a high churn tactical approach only. The research ability or quality of the PMS house should be judged or tested before making a final call on a PMS.
✓ Communication mechanism: PMS as a product is expected to have more direct access to a portfolio manager. This factor is often seen missing in many cases, which makes an investor one among many. Investors often prefer a PMS that has a better communication mechanism with the portfolio manager.
✓ Technology: Investors of today prefer a regular update on the portfolio through any medium possible. This makes it important for the portfolio manager to have a technology led back-office to be able to offer meaningful services.

According to SEBI, “A portfolio manager is a body corporate who, pursuant to a contract or arrangement with a client, advises or directs or undertakes on behalf of the client (whether as a discretionary portfolio manager or otherwise), the management or administration of a portfolio of securities or the funds of the client.”
- Portfolio Manager

Advantages of IAS

Investment advisory service (IAS) is popular with both retail investors and HNI investors. Most investors prefer hiring an investment advisor with a good reputation not only because it is cost-effective when compared to PMS but also because there is lot more control in decision-making. One of the biggest advantages of hiring IAS is the flexibility with which the investors can operate in the market. There is no minimum ticket size nor is there any restriction on how much one can invest. There is no exit cost as well.

Says Hyderabad-based Srinivas Rao, a long-term portfolio investor: “I depend on my investment advisor for stock selection. I have my portfolio strategy defined and regularly monitor it. I place my own orders and actively participate in the markets. I like to do that because by placing my own orders I feel I am in sync with what is happening in the markets and I have a clear idea of the shares I have bought and at what price. A good equity advisor is important as it is not possible for me to research so many stocks. I get a quality list of stocks and then I decide how much to invest in which stocks because one thing I have learnt is that weightages in a portfolio is as important as the quality of stock itself.”

“My advisor also assists me on portfolio construction at minimal charges. My annual spend of investment advisory is not more than Rs 20,000 per annum while my assets are more than Rs 50 lakhs. That works out to about less than half a per cent of my total portfolio value. The fixed costs are very low for me and I do not have to share my profits. I thought of hiring a PMS but then decided against it because I want to be in control of my portfolio. Besides, I am able to beat the markets anyways with the help of my advisor. Also, in my personal opinion, it is easy to switch to a new IAS but very difficult and costly to switch to a different PMS once you have hired someone,” he says.

“Hiring a PMS is like buying a Mercedes Benz– the maintenance cost can be really unaffordable for someone who is not that wealthy. With a quality IAS I can derive the pleasure of driving a Mercedes (returns) while keeping the maintenance cost (charges) as low as required by a Maruti Suzuki car. In other words, if returns are taken care of at a lower cost why go for an expensive option?” he further states. Indeed, customisation is the key for many investors and by hiring different IAS’ an investor can optimally plan his or her investments. Investors can hire technical advisory services or focus on small-cap and mid-cap stocks ideas or large-cap stock ideas. As value investors you can hire services which provide ‘value stock’ ideas. If you are a momentum investor you can always hire ‘momentum investing’ stock ideas. With IAS there is huge amount of flexibility available at affordable cost that may not be available with PMS.

Conclusion

Clearly enough, both PMS and IAS have their unique advantages and disadvantages. Practically speaking, both cater to different kinds of clienteles and provide a customised solution taking into consideration the risk profile and investment objective of the clients. PMS obviously is suitable for those investors with higher ticket size and for those who want some access to the portfolio manager to understand the strategy deeper so that the conviction level is higher while investing large sum of monies. By opting for investment advisory services the investor and trader is more in control and is responsible for the trade execution and overall portfolio hygiene.

Majority of Indian investors like to be in control of their portfolio and usually prefer to take their own investment decisions with some help from experts. Between PMS and IAS neither can be said to be superior or inferior to each other; it is just that they offer different levels of customisation which the investor will have to choose from. That said, there is no evidence that opting for PMS generates higher returns. One has to take a long-term view while evaluating both PMS and IAS. In long run the returns of some of the most popular PMS’are comparable to the best performing equity-oriented mutual funds.

Due to lack of data it is not possible to estimate the average returns delivered by the equity advisors, even though several of them do publish details of the annual performance. All said and done, a good PMS and a good equity advisor is what an investor requires. It is the ability to spot the winner while choosing PMS or a good equity advisor on board is what will help an investor create wealth. When markets are on a song the returns will pour in both the options. The trick is to analyse the drawdown in both the cases when the markets crash to get a perspective on the riskiness.