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Mutual Fund Vs. Portfolio Management Service (PMS) – Suitable for Whom?

Till very recently, there was a steadily growing interest among small investors about PMS. In fact, the number of queries on lines of ‘Is PMS better than mutual funds?’ saw a constant rise in the last few years.

And why not?

After all, the Portfolio Management Service or PMS had long been perceived as some sort of exotic investment product, which offered high returns to sophisticated investors.

Right?

But after the recent (and I am afraid ongoing) stock market carnage, especially in the non-large cap space where most of these PMS schemes operate in, the PMS investors have experienced the obvious-but-often-forgotten downside of high-risk taking.

No… I am not pointing any fingers on any PMS fund managers here.

PMS schemes, by design, are high-risk products which are focused on enhancing returns for investors by taking (and not surprisingly) very high concentrated risks at times. Sometimes this works and the results are phenomenal (If you search for the returns delivered by best portfolio management services in India in good years, you will understand how much). But at other times, it doesn’t and the results are horrible.

PMS is an equity product and falls on the higher end of the risk spectrum. And due to its concentrated portfolio and the high inherent risk, it is best suited for investors with prior market knowledge and understanding.

But small investors are small investors for a reason. 😉 Lured by the eye-popping claims* of high returns made by the PMS funds in India, many small less experienced and gullible investors got attracted to PMS funds in recent times. Unfortunately, they focused just on the returns and not on the risks.

It was exactly like trying to cover a 500-km journey fast by driving at 150+ kmph. You may reach the destination in 3.5 hours. But at such high speeds, there is an obvious risk of life-ending accidents.

Same is the case with PMS. High speed (returns) come with high risk-taking. Plain and simple.

* Not all PMS do well as it seems to outsiders. Many can’t even beat simple well-diversified equity funds.

That said, I am a strong believer that equity can create enormous wealth for people in the long run. But that doesn’t mean that anyone and everyone should be fully invested in equity. Different people have different goals and their portfolios should be constructed accordingly. Even within the equity space, the exposure to different types of shares comes with different levels of risks. And people forget this.

At the cost of sounding repetitive, I would say that when it comes to equity, most Indian investors are better suited for the Mutual Funds. In the choice of PMS vs Mutual Funds, it can be said that PMS is best left for people who actually understand the consequences of high-risk strategies and have decently large portfolios (of which a small part can be parked in high-risk strategies like PMS).

That brings us to the differences between PMS and Mutual Fund.

You already know what a mutual fund is and what are the different categories of mutual funds and what are the various types of mutual funds. So I won’t address that aspect.

Let’s instead see what a PMS exactly is and then we will discuss what suits whom.

Portfolio Management Service or PMS is an investment vehicle that replicates investment strategies made available by the PMS fund manager in the client’s portfolios.

There is a perception that PMS offers a great degree of customization. And this is considered by many as one of the key benefits of Portfolio Management Services apart from the perception of a high-return-promise. But this isn’t the case for every PMS or for every PMS investor. Most PMS offer standardized model portfolios for smaller clients. Once a client is on-boarded, the manager will try to replicate the client portfolio to as close to the model portfolio as possible. But the real customization is available only to the large clients – who can invest atleast a few crores in the PMS. If the client account size is big enough, the PMS manager will give proportionately large attention to the creation of a customized portfolio (broadly in line with PMS model portfolio or strategy if need be) to cater to the client needs. Remember, Such levels of customization is not available for smaller PMS clients.

What else?

Unlike mutual funds which are tightly regulated by SEBI and to some extent AMFI, the PMS is very less regulated and hence, allows fund managers to take a lot of risks. This can also be seen as extra flexibility available to PMS managers. But this no doubt increases the risk too as the fund manager has a free hand.

So for less experienced clients, such a level of risk-taking isn’t even required.

Note – And if you do check portfolio management services SEBI circulars and compare it with those of mutual funds, you will also realize that PMS managers are less answerable than MF AMCs.

Since the risks are high in PMS, the regulator has set a minimum investment limit of Rs 25 lakh in PMS to keep it out of reach of very small investors. Whereas in Mutual funds, you already know that you can even start with Rs 1000 per month SIP.

The most important thing apart from the highly risky nature of the product itself is the high fee that PMS charges. In MFs, you pay about 1-2% on the amount as expenses. In PMS, the fee has 3 distinct components:

  • Upfront setup fee paid during the initial investment
  • Fixed ongoing Management fee (annual fee)
  • Performance fees – generally as a share in profits generated

The basic fixed (on-going annual) fee is 2-2.5% per annum. But depending on the size of individual accounts, the on-going fee or performance fee is based on mutual agreement. So for example, someone investing the minimum Rs 25 lakh in a PMS may have to pay a 2.5% recurring annual fee whereas a Rs 5 crore investor in the same PMS strategy may be paying a lower fee (1-1.5%) as he brought in more money to the table.

Apart from the annual fixed fee (and unlike in MFs), PMS also has performance-linked fees (called profit share). This applies when the gains cross a predetermined level.

For example, a PMS can have multiple offerings like:

  • 50% annual fee + performance fee of 10% of the gains above 15%
  • 50% annual fee + performance fee of 15% of the gains above 12%
  • 25% annual fee + performance fee of 20% of the gains above 10%

This fixed fee + performance fee structure makes PMS cost higher and it eventually eats into the portfolio returns if the returns aren’t being delivered. And given the high risk that comes associated with PMS investments (and for those who aren’t very aggressive), mutual funds are more prudent investment option in equity and far cheaper. Remember, the investor can negotiate the fee with PMS providers depending on how much money he is investing with them.

But think about it – PMS which were earlier considered a product for the rich and the sophisticated, are now being pushed by agents, distributors and banks much more aggressively to everyone capable of sparing Rs 25 lac!

Why is it?

I will tell you.

SEBI, the regulator has been steadily curbing the commissions on the sale of mutual funds. So the distributors get attracted to the relatively high upfront commissions given to them by PMS operators. So the distributors, in order to protect their income are hard-selling clients to opt for these high-upfront-commission PMS schemes in spite of knowing that they might be unsuitable for them.

Now you know why its gaining popularity 😉

Is PMS for you?

I will put this very plainly here.

Based on the little experience I have and things I understand (or atleast feel that I understand…), most people are better off not investing in PMS. When it comes to equity investing, most people are best served by investing in mutual funds alone.

In any case, the entry limit of Rs 25 lac is high enough for very small investors.

But just because you have Rs 25 lac to invest in equity doesn’t mean that you are suited to invest in PMS. Just because you can doesn’t mean you should.

PMS is suitable for high net worth (affluent) and institutional investors with a suitably large investment portfolio. There is no perfect threshold figure here but let’s say that unless you have a few crores to invest, you shouldn’t even think about PMS. 

And since the product is high-risk, its best to keep exposure limited to a small percentage of the overall portfolio if you eventually do invest in it.

So for example – Let’s say your overall portfolio is Rs 10 Cr. Now based on some goal-based analysis, it is found that your asset allocation should be 50:50 equity debt. So that means Rs 5 Cr for equity and the other Rs 5 Cr for debt. Now out of the Rs 5 Cr for equity, it’s best to limit the PMS exposure to 10-20% here for most large and aggressive investors too.

Why?

Because just because you are investing in equity doesn’t mean that you go straight full to the highest risk component. You divide the equity corpus between various levels of risk. Right? That’s how a prudent portfolio is built.

It is also suited for more sophisticated clients having large portfolios who wish to invest in themes that aren’t easily available through mutual fund portfolios. In such cases, the PMS manager can create tailor-made solutions for larger clients.

Sorry for this long rant.

If you have had enough of this Mutual Fund vs PMS debate, and wish to go away with just a few things from this article, then here they are:

  • PMS is a high-risk equity product which is suitable for sophisticated investors who know what high-risk concentrated equity portfolio investing really is.
  • PMS is not suitable for small investors.
  • Just because you have Rs 25 lac (minimum required) to invest doesn’t mean that you are suitable to be a PMS investor
  • If your agent, bank is pushing you to buy it then remember that he gets good commission and may not be advising you as per your needs or product suitability.
  • For most of you, it’s better to stick with Goal-based Investing and take the route of Mutual Fund investing.

Now don’t ask me if PMS is better than mutual funds or which is mutual funds or PMS? You already know what I think after having read till here.

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Written by Dev Ashish

Founder - Stable Investor Investing | Personal Finance | Financial Planning | Common Sense

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