How is portfolio management beneficial?
What if you have money, know that you have to invest but do not know how to go about it? The answer is portfolio management. Let us look at a practical situation. For a moment that you have a corpus of around Rs.2 crore either in your bank or in the form of shares. What can you really do with these funds? There are various possibilities. Firstly, you can select stocks and create a portfolio of equity stocks and constantly monitor the same. That sounds exciting, but it is not as simple as it sounds.
The other option is to allocate the entire monies to a set of mutual funds and diversify your risk. That works for a Systematic Investment Plan (SIP) or a smaller corpus, but with a corpus of Rs.2 crore, you can do a lot more. Look at the third option of portfolio management via a PMS. You can hand over these funds to one of the registered Portfolio Managers who are running a Portfolio Management Service (PMS). By default, only SEBI registered portfolio managers can run PMS schemes in India. This is not everybody’s cut of tea.
What is the portfolio management service all about?
Portfolio management service or PMS is a professional fund management service that is performed by experienced and high quality fund managers. They actually manage money on your behalf, identify the right investment opportunities, churn the money when opportunities arise and also give you constant updates and reports on your portfolio performance. Above all, they not only take into consideration returns but also risk, liquidity and tax efficiency of investments.
Does the portfolio management service look somewhat like a mutual fund? There is a very subtle difference. Unlike a mutual fund, a PMS creates unique portfolios for each PMS participant or PMS client. It is not one general portfolio for all the unit holders. The base corpus required to qualify for a PMS Service is Rs.1 crore in most cases but smaller amounts are also accepted as this industry goes more mass affluent with the rise of technological innovations. The key difference is that there is a lot more customization happening in a PMS account to your unique needs and there is a unique portfolio you can monitor online.
Portfolio management can be discretionary or non-discretionary
There are two types of PMS services that are available based on the type and quality of interaction and fund manager discretion that you want to offer. The first is the Discretionary PMS and the second is the non-Discretionary PMS. Let us look at what these are all about.
The Discretionary PMS is about giving complete leeway to the PMS fund manager to select stocks and create a portfolio for you. Of course, even in this case there is a broad policy framework that is first put in place and even the discretionary decisions will only be taken within the contours of this framework. The fund manager is required to adhere to such conditions while selecting stocks and other asset classes for you.
On the other hand, the non-discretionary PMS does not give discretion to the PMS fund manager and to that extent it is more of advisory and the final execution is in the hands of the investor. While the funds will be handed over to the PMS, the fund manager will be required to take client approval before any transaction and any unapproved transaction can be treated as null and void and the investor can claim compensation for such transactions. It is discretionary PMS that is more popular as some amount of fund manager leeway is required for the PMS business to be effective.
What are the advantages that portfolio management brings to the table?
In what ways does portfolio manager actually score as a method of handling your money over random investing or even mass MF type investing?
Unlike in the case of mutual funds, you are not subscribing to the units of a pre-created portfolio or a standardized mass defined portfolio. Mutual fund schemes are mass customized. On the other hand, PMS is customised specifically to the unique needs of the particular customer only.
Most PMS Service providers provide online add-ons like easy access to portfolio, portfolio analytics, high-end blogs and content to enhance your portfolio experience. These are useful value-adds especially if you are looking at additional value for money.
Transparency is not only mandatory but also key to any PMS. The PMS is regulated by SEBI regulations and hence there is oversight on what is being done and how the funds are being managed. PMS service providers are statutorily required to give a variety of disclosures to the PMS holders and to the regulator at periodic intervals. This increases transparency for the portfolio management activity, although the PMS does not have to make public disclosures unlike a mutual fund. PMS disclosures are private for investors.
Does portfolio management give above normal returns and does it generate alpha? Normally, PMS funds tend to give superior returns for two reasons. Firstly, they are able to spend time and dedicate a lot of energy and focus picking quality stocks and holding on for a longer period of time. Another reason is that, since the PMS is more flexible compared to a mutual fund, it can use derivatives and structured products to enhance returns. These are some of the advantages that portfolio management brings.
Are there any downside risks to portfolio management services?
One can think of two downside risks in the portfolio management service compared to a traditional mutual fund approach.
One of the major risks of a PMS is the relatively higher costs. While the expense ratio in case of an equity mutual fund is around 1.05-1.25% for a direct plan of mutual fund, the expense ratio in case of PMS can range from 3.5-5.5%. This will depend on the extent of customization and in some cases there is also a profit sharing clause in these PMS agreements. That takes away a good chunk of your returns, especially in a bad year.
PMS is relatively less tax-efficient compared to a mutual fund. That is because, Mutual Funds are recognized as a trust and hence it gets pass-through benefits. That means; profits earned by the mutual fund are not taxed. However, in case of PMS, the transactions happen in your account and hence every transaction becomes liable to tax on LTCG / STCG as the case may be, apart from all the transaction costs.
Specialized portfolio management is a product that is more suited to the high net worth investor who has a larger corpus. Of course, you need to take a final call after weighing the pros and cons to see if portfolio management is really adding value to you or not.