Mutual funds vs PMS – Pros and Cons

For investors who can write a single cheque of Rs 50 lakh or more, Portfolio Management Services (PMS) have emerged a popular vehicle for investment into equities. In effect, PMS is identical to investing directly in shares, the main difference being that you have given absolute power to the PMS agency to buy/sell shares on your behalf and your portfolio choices are left to them. 

You can enroll in a PMS by either giving a cheque or shares worth the minimum value. If you give shares, the PMS manager will revamp your portfolio and may sell some of the shares you own. Taxation wise, it is the same as if you directly bought and sold. PMS is generally limited to investing in listed equity or debt.  There is another family of portfolio services if you can write a cheque for a crore of rupees and above. It is grouped under a family name of “Alternative Investment Funds” or AIFs. AIFs and PMS’ differ in a significant way. In AIF, the assets of multiple investors in a scheme are pooled together. In PMS, your portfolio is identified with you alone. AIFs can invest across asset classes, can be leveraged, can go short or long. Here, I am limiting my discussion to PMS.

Mutual funds vs PMS – Pros and Cons

Where PMS scores

For investors who prefer the direct route to equities, the PMS route offers some distinct advantages. Unlike MFs whose performance is measured against indices over short periods such as a month, quarter or year, PMS are generally not benchmarked to any index. This gives the manager complete flexibility in choosing scripts and assigning weightages. There is no compulsion to mimic any index. But the investor has come to PMS seeking returns higher than a mutual fund or the index, so the index should be a rough benchmark to evaluate PMS performance.

Unlike MFs where individual stock weights are capped at 10% and sector weights at 25%, PMS managers have absolutely no restrictions on diversification or concentration of investors’ portfolios. As they claim to be experts, they should be able to deliver far superior returns as compared to MFs or benchmark indices. Just as an aside, a PMS manager can benchmark to the Nifty50, pick some stocks that are going to do badly and keep away from them. If he has a great pick, he can take on a substantial position size to impact the overall portfolio. He can also go wholly into cash, if market conditions are hostile. I know of one PMS manager who went to over 50% cash at one time!

My expectation from a PMS would be that in a bull market, I beat the index comfortably and in a bear market, the drawdown is far lower than the fall in the index. Tracking the index is not what I seek from a PMS. For this, I would rely on ETFs and MFs. I am seeking superior returns from the stars and experts in the industry.

The fees

Generally, PMS charge annual fees of around 2.5% of assets and in addition there is a ‘performance’ fee that is either linked to a hurdle rate (say ten percent) or to some other agreed benchmark. This can be 10 to 20% of the excess returns over the agreed hurdle rate.  There are PMS’ with higher and lower fee structures too, depending on negotiations. In many cases, the fees are shared with the distributor. We are yet to see a formal ‘direct’ version of PMS like we have with mutual funds. 

PMS fees are typically higher than what mutual funds levy. The maximum TER that mutual funds can charge on equity funds is 2.25% and the fund size gets bigger this cap goes down to 1.05%. On direct plans, fees are typically lower. Investors also need to note that the performance fee on PMS is annual. This means that if I stay invested for five years and end up with no returns at the end, I would still have paid performance fees in the years when there was an excess over the hurdle rate! In volatile assets like equity, the average return is a function of duration. So it would have been ideal if the performance fee were only chargeable at the point of exit by an investor.

Taxation

MFs are treated as pass-through entities for taxation. So the investor is subjected to capital gains (Short /Long etc) only when he buys or sells units. The MF might be churning the portfolio any number of times and this is not taxed and nor does it entail taxes on the investor. In a PMS, every trade is treated as if it is the investor who has done it and therefore, excess churn by the PMS goes to reduce your effective returns. To this extent, there is a disadvantage in PMS. Of course, if a PMS has low churn it can be comparable to MFs. 

If the PMS manager is picking stocks for the long term, then the churn should be minimal. The argument in favour of churn is that as a fund manager, one may like to trade on the inventory in order to generate higher returns. For example, a PMS can buy HDFC Bank shares and it delivers, say, 14 percent return point to point, over a year. As a professional manager, one can say that it trades in a range which gives me an opportunity to sell and buy it back, with a gain of at least Rs.20 each time. If one trades it ten times in a year, one gets an extra Rs.200 as return. Even after taxes, there is a positive addition to the total returns through this kind of trading.

Disclosures

In a mutual fund, you get to know about the portfolio of the scheme where you are a unitholder, typically through an end-of-month factsheet. You do not know what happened in between two sets of data. And funds have been known to take short term positions in-between disclosure dates. In a PMS, you know every trade as it happens, because you are authorizing it. This leads to more timely disclosures on portfolio moves. 

All the above factors indicate that a PMS “should” be a preference over an ETF or mutual funds for investors whose primary focus is wealth creation, because the vehicle is designed to generate great returns. If you are not an expert at picking stocks, that’s why you seek out the PMS manager. You trust his skills and expect better returns than a MF, which is why you are willing to pay a higher fee as compared to a MF.

The PMS landscape

The landscape:

There are around 1.35 lakh investors in the PMS segment as against over 10 crore ‘folios’ in the MF industry and about 3 crore unique investors. 

PMS returns are available on the SEBI website.  But the website of PMSBazaar.com which provides an extensive range of information and data on PMS is friendlier and easy to use.

Taking stock of the returns of schemes that manage over Rs 1000 crore from PMSBazaar’s October 2022 newsletter, here’s what I find. (PMS without asset disclosures are excluded)

The data above clearly brings out the substantial return divergence between PMS schemes even within a category. Some have done well. Some have done quite badly. The trend clearly seems to track the broad indices, even if managers have the liberty to remain in cash. Clearly, choosing one is not easy. A big-name brand and size are no indicators of performance. 

Please note that reading PMS returns is not that easy. Read this article on SEBI’s requirements and the divergent reporting practice in performance disclosures.

What’s more, in the case of PMS, unlike MFs, the returns on model portfolios disclosed by the managers can diverge quite a bit from individual investor returns. This goes to show that choosing the right PMS to invest in is an extremely demanding task. Given the complexity, you will not be very worse off if you simply put your money into ETFs on the three indexes. The industry is a minefield and one has to step very carefully.  The only data we do not seem to have is the incidence of taxation on these returns, which can make a big difference to the net returns to the investor.  

Therefore, while PMS do have many advantages, there’s a dark side too. In the good old days, PMS managers were allowed ‘pooled’ accounts which allowed a lot of malpractice. PMS schemes can also be abused by being used as a vehicle for parking illiquid shares, price manipulation games etc. But today, with increased disclosures, I am hopeful that these practices do not exist. In any case, when you get to know what you buy, you can make a reasonable judgment on the credibility of the PMS manager. The PMS manager will give you a rationale for buying a share as well as for selling. 

SEBI must be commended for raising the bar on PMS reporting, but there are still some gaps. It would be useful if reporting of AUM is made compulsory. I hear of cases where inflated figures are given to potential investors. I also wish SEBI would regulate the performance fee based on the stay of the investor rather than on a financial or calendar year-based relative performance. The other thing that SEBI can do is to bring about a two-tier fee structure like MFs- those who come through brokers and those who come directly.

Finally, one personal observation. When a PMS manager talks in the media, any comment on specific stocks should be avoided. Celebrity portfolio chasing is generally not a good thing. Yes, it is fine so long as the person also talks about selling it BEFORE he actually sells it from the portfolio. But this is not practical. It is surely an issue of governance and maybe SEBI will one day address it. Given all this, if I have enough resources, I would first build an ETF portfolio before opting for a PMS scheme. But I will surely negotiate hard on the fee with the provider of the PMS.

(I have not touched upon the debt PMS at all. Our debt markets are illiquid. I would rather invest directly into debt, if I have to.)

More like this

15 thoughts on “Mutual funds vs PMS – Pros and Cons”

  1. It is possible to go direct with some larger well known PMS – this saves a majority of commission fees. I personally was also able to request for rolling returns data after getting in touch with direct ‘marketing’ team, but decided not to invest as I decided 50L was too large a commitment for me.

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Except where otherwise agreed in writing with the RA, material on the Website is solely for the client’s personal, non-commercial use. Except as provided below, the client must not copy, reproduce, republish, upload, post, transmit or distribute such material in any way, including by e-mail or other electronic means and whether directly or indirectly and the client must not assist any other person to do so.

Without the prior written consent of the RA, modification of the materials, use of the materials on any other web site or networked computer environment or use of the materials for any purpose other than personal, non-commercial use is a violation of the copyrights, trademarks and other proprietary rights, and is prohibited. Any use for which the client receives any remuneration, whether in money or otherwise, is a commercial use for the purposes of these Terms.

The client may occasionally distribute a copy of a research report, or a portion of the same, from the Website in non-electronic form to a few individuals without charge, provided the client includes all copyright and other proprietary rights notices in the same form in which the notices appear, original source attribution, and the phrase “Used with permission from PrimeInvestor Financial Research Pvt. Ltd.”

While the client may occasionally download and store research reports or information from the Website for his/her personal use, he/she may not otherwise provide others with access to the same. The foregoing does not apply to any sharing functionality we provide through the Website that expressly allows the client to share Content or links to Content with others. In addition, the client may not use Content he/she has downloaded for personal use to develop or operate an automated trading system or for data or text mining.

The client agrees not to rearrange or modify the Content available through the Website. The client agrees not to display, post, frame, or scrape the Content for use on another website, app, blog, product or service, except as otherwise expressly permitted by these Terms. You agree not to create any derivative work based on or containing the research products and Content. The framing or scraping of or in-line linking to the Services or any Content contained thereon and/or the use of webcrawler, spidering or other automated means to access, copy, index, process and/or store any Content made available on or through the Services other than as expressly authorized by us is prohibited.

The client further agrees to abide by exclusionary protocols (e.g., Robots.txt, Automated Content Access Protocol (ACAP), etc.) that may be used in connection with the Research Services. The client may not access parts of the Research Services to which he/she is not authorized, or attempt to circumvent any restrictions imposed on your use or access of the Services.

As a general rule, the client may not use the Content, including without limitation, any Content made available through one of our RSS Feeds, in any commercial product or service, without our express written consent.

The client may not create apps, extensions, or other products and services that use our Content without our permission. The client may not aggregate or otherwise use our Content in a manner that could reasonably serve as a substitute for a subscription to the Website.

The client may not access or view the Services with the use of any scripts, extensions, or programs that alter the way the Services are displayed, rendered, or transmitted to you without our written consent.

The client agrees not to use the Services for any unlawful purpose. We reserve the right to terminate or restrict the client's access to the Website if, in our opinion, the client's use of the Services may violate any laws, regulations or rulings, infringe upon another person's rights or violate these Terms.

Prohibited content: The Website includes comments sections, blogs and other interactive features that allow interaction among clients and between clients and the RA. We call the information posted by or contributed by users “Contributed Content.” In the course of availing of the Research Services or uploading any post or comment on the Website, the client shall not post any Contributed Content that (i) contains nude, semi-nude, sexually suggestive photos, (ii) tends or is likely to abuse, harass, threaten, impersonate or intimidate other users of the Website and/or Research Services, (iii) is lascivious or appeals to the prurient interest or if its effect is such as to tend to deprave and corrupt persons who are likely to use or have access to the Website and/or Services, or (iv) otherwise violates, is prohibited or restricted by applicable law, rule or regulation, is offensive or illegal or violates the rights of, harms or threatens the safety of other users of the Website and/or Services (collectively “Prohibited Content”).

We reserve the right to cease to provide the client with the Research Services or access to the Website, or terminate your subscription, with immediate effect and without notice and liability, for violating these Terms, applicable law, rules or regulations and reserves the right to remove Prohibited Content which is in violation of these Terms, or is otherwise abusive, illegal or disruptive. The determination of whether any content constitutes Prohibited Content, violates these Terms, or is otherwise abusive illegal or disruptive, is subject to the sole determination of the Firm.

Changes to Research Services: We are constantly endeavouring to improve the quality of Research Services provided to our clients. Due to this, the form and nature of the Research Services provided may change from time to time without any prior notice to the client. We reserve the right to introduce and initiate new features, functionalities, components to the Website and/or Research Services and/or change, alter, modify, or discontinue existing ones without any prior notice to the client.

Warranty and liability disclaimer: The Website, Research Services, and all the materials and services, included on or otherwise made available to the client through this Website is provided by the RA on an “as is” and “as available” basis without any representation or warranties, express or implied except otherwise specified in writing. Without prejudice to the foregoing paragraph, the RA does not warrant that:

  • This Website and/or Research Services will be constantly available, or available at all;
  • The information on this Website or provided through the Research Services is complete, true, accurate or not misleading; or
  • The quality of any products, services, information, or other material that you obtain through the Website or Services will meet your expectations.

The RA, to the fullest extent permitted by law, disclaims all warranties, whether express or implied, including the warranty of merchantability, fitness for particular purpose and non-infringement. The RA makes no warranties about the accuracy, reliability, completeness, or timeliness of the Website, Research Services, Content, Contributed Content, Services, software, text, graphics and links.

The RA does not warrant that this Website, Research Services, information, content, materials, or any other material included on or otherwise made available to you through this Website, their servers, or electronic communication sent by the RA are free of viruses or other harmful components.

Nothing on this Website constitutes, or is meant to constitute, advice of any kind.

Indemnification: The client:

  1. Represents, warrants and covenants that no materials of any kind provided by him/her will:
    1. Violate, plagiarise, or infringe upon the rights of any third party, including copyright, trademark, privacy or other personal or proprietary rights; or
    2. Contain libellous, Prohibited Content or other unlawful material;
  2. Hereby agree to indemnify, defend and hold harmless the RA and all of the RA’s officers, directors, owners, agents, customers/clients, information providers, affiliates, licensors and licensees (collectively, the “Indemnified Parties”) from and against any and all liability and costs, including, without limitation, reasonable advocate’s fees, incurred by the Indemnified Parties in connection with any claim arising out of any breach by the client of these Terms or the foregoing representations, warranties and covenants. The client shall cooperate as fully as reasonably required in the defence of any such claim. The RA reserves the right, at its own expense, to assume the exclusive defence and control of any matter subject to indemnification by the client.

Applicable law: This Website, including the Content and Contributed Content and information contained herein, and the provision of Research Services shall be governed by the Securities and Exchange Board of India, laws of the Republic of India and the courts of Chennai, India which shall retain exclusive jurisdiction to entertain any proceedings in relation to any disputes arising out of the same. As such, the laws of India shall govern any transaction completed using this Website.

Information gathered and tracked: Information submitted or collected on the Website or pursuant to the use of the Services is stored in a database. Specifically, we store the username, name, e-mail address, contact number, as submitted or collected on our Website or through the provision of the Research Services. We may use such information to send out occasional promotional materials, including alerts on new Services available, or other promotional and marketing material relating to our clients and customers.

In accordance with the Information Technology Act 2000, the name and the details of the Grievance Officer at PrimeInvestor is provided below:

Mr. Srikanth Meenakshi
PrimeInvestor Financial Research Pvt. Ltd., Registered office: 659, 4th Avenue, D-Sector, Anna Nagar Western Extension, Chennai 600 101.
Email: [email protected]

11. Mandatory notice:

Clients shall be requested to go through Do’s and Don’ts while dealing with RA as specified in SEBI master circular no. SEBI/HO/MIRSD-POD-1/P/CIR/2024/49 dated May 21, 2024 or as may be specified by SEBI from time to time.

12. Optional Centralised Fee Collection Mechanism:

SEBI has operationalized a centralized fee collection mechanism for IA and RA. Under this mechanism, clients shall pay fees to IAs/RAs through a designated platform/portal administered by a recognized Administration and Supervision body. This is an optional mechanism for the registered entities. At this time, PrimeInvestor has opted out of this fee collection mechanism. Therefore, all subscription payments for the Research Services will be through the modes as specified in Clause 5 of these Terms.

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