Portfolio Management Service (PMS) as an asset class has grown at exponential rates over the last few years. Over the last three years, as of June 19, the number of discretionary clients under PMS has grown by 175% from 52,761 clients to 1,44,879 clients and the AUM under discretionary mode has gone by about 56% from Rs. 8,49,126 crore to Rs. 13,28,285 crore¹. Still, based on trends in other markets, there is still huge potential. In the USA Separately managed accounts (similar to PMS in India) represent more than a third of the equity assets.We expect this asset class to continue to expand because of a number of reasons and we articulate some of them:
Offers strategies to provide better risk adjusted returns:
PMS offers options to invest in strategies that are not always available from traditional means. One of the strategies is to follow an absolute return approach. We invest only when an investment is justified on an absolute basis. As such, we do not deploy investor money if we can not justify owning stocks. In other words, we can hold part of the portfolio (or for that matter even entire amount) in liquid investments if we are not able to justify owning enough stocks that meet absolute return criteria. In some sense, this is the same way, one would invest on her own. In our experience, such a strategy produces better outcome as evident from our absolute and risk-adjusted return performance data. Unlike the vast majority of mutual funds, we are able to outperform the benchmark in spite of not running a benchmark based strategy. As a result, Investors can enjoy superior returns while taking a lower risk by investing through carefully chosen alternative asset class product. PMS strategy in particular also allows for customization of an individual portfolio to meet the specific needs of every investor.
Access to some of the brightest minds in the industry:
Because of lower barriers to entry than a mutual fund, many successful professionals confident of their investing skills set up their own PMS. As such, investors get access to such talented professionals only through funds in the alternative asset class. Being run in an entrepreneurial setup by a fund manager who is keen to prove his name and must deliver value to survive, such funds can be a very useful option for discerning investors – investors can expect better service as well as access to the fund manager. Investors may also get better access to information related to investment rationale and in some cases also get an opportunity to interact with the fund manager.
Transparency of the portfolio:
Transparency and ownership are also big advantages of an alternative asset class such as PMS. Unlike Mutual Funds, where an investor can view the holdings only at the end of the month, an Investor in PMS knows exactly what is happening in his account and retains ownership of securities with an added advantage of a professional fund manager choosing them. For large investors, direct ownership can be of value when shareholder voting becomes crucial.
PMS versus AIF Category III:
Over the last few years, AIF (in context of Category III) has emerged as an alternative to PMS. While AIF allows the fund manager to manage the portfolio like a fund this advantage is largely nullified because of the way PMSes are managed today. Fund managers have access to tools that allow them to manage a large number of individual accounts in a manner that mimics that of a pooled vehicle such as AIF while retaining the individuality of each accounts. From taxation perspective, PMS taxation is very well established whereas due to lack of pass-through, some uncertainty does remain related to AIF especially related to the treatment of short term gain on sale of equities. Also, with a sharp increase in tax surcharge, the applicable tax rate can be as high as 42% for part of AIF income that needs to be classified as business income. Therefore, even those investors who would otherwise not be subject to such high tax would end up paying the high rate. Furthermore, PMS enjoys one clear advantage for fund managers like us who want to be able to generate alpha from high portfolio concentration. With a 10% limit per investment, such an opportunity is not available to AIF investors.
Alignment of Investor interest :
Many PMS managers emphasize their willingness to align themselves with the investor. This comes through in multiple forms but foremost is the focus on earning fees from the performance. Fixed fees are kept as low as 0.5% or even zero in some cases. Furthermore, some of us use compounded hurdle rate and charge performance fee only above such hurdle rate. This coupled with high watermark principle ensures that investor pays performance fee only if the fund manager delivers consistent superior returns. The fee differential can become significant over time considering that many equity mutual funds charge fees closer to 2.5%. More importantly, mutual fund fees are payable regardless of performance unlike some of the alternative asset class structures. Another important way a fund manager can align himself to the investor is by using the same PMS structure to manage his own money. We practice such an approach.
1. Source : SEBI