MFs or Portfolio Management: Which is right for you?

If you have a little bit more money to invest, Portfolio Management Services or PMS may be an interesting alternative for you.

When people think equities, they usually think mutual funds. While mutual funds are the most common equity investment vehicle, PMS is also a viable alternative. In the previous piece, we spoke about mutual funds and how to select them; here we discuss PMS, how it is different from mutual funds, and how to select a good PMS.

What is the difference between a PMS and a mutual fund?
Mutual funds and PMS are the two SEBI approved investment alternatives in India. A mutual fund pools the assets of a large number of investors into one scheme and all the investors' money is collectively managed. A PMS treats each client as an individual client, and tailors a portfolio for the client's individual needs. A PMS investment is made in the individual client's name.

Mutual funds are a more regulated structure that provides a common portfolio to all investors, while PMS is a more flexible, but still regulated structure, where the investment depends on the agreement with the client. Mutual fund investments cater to individuals with smaller ticket sizes (under Rs 5 lakh) while PMS investments cater to individuals with more money to invest.

The author is the co-founder of Forefront Capital Management (www.forefrontcap.com), a specialised investment advisor providing portfolio management services and mutual funds. She is a Wharton and McKinsey alumnus and has managed billion-dollar portfolios as a portfolio manager with AQR Capital in the US. She can be contacted at radhika.gupta@forefrontcap.com.

• A more unique and customised investment that is structured to your needs and risk appetite, and more creative strategies than a mutual fund.
• Access to some of India's most successful money managers who only offer PMS and have not set up a mutual fund structure.
• A PMS manager can implement investment constraints specific to you, eg not holding a particular stock or sector, Shariah constraints, etc.
• Your investments are not pooled with anyone else and you hold all the securities in your name.
• Because your investments are not pooled, you don't bear the costs of other people's transactions, such as when a large institutional investor comes in and out of the mutual fund. PMS managers will typically provide you complete transaction and holding statements, as well as audited tax statements.
• PMS managers are permitted to take securities, and you can transfer your existing stock portfolio rather than funding in cash.
• A PMS will give you more personalised service, with access to a relationship manager or fund manager who will monitor your investment needs.

• PMS products have higher minimum sizes than a mutual fund, starting at Rs 5 lakh.
• Since the assets are not pooled, with a PMS, you have to open a new demat account, which the portfolio manager will guide you through.
• The KYC process is not common to every PMS manager, unlike mutual funds, where there is only one round of paperwork.
• Some PMS managers invest only in small cap stocks, leading to a high-risk high-return portfolio.
• A PMS can be less tax efficient than a mutual fund, if the portfolio manager churns the portfolio a lot. Check with your tax advisor on what your individual situation is.

It depends. A good portfolio manager will have an edge over the average mutual fund, because he should be able to move a substantial portion of your portfolio to cash in a falling market and protect your portfolio.

Unfortunately, many investors in PMS have had their portfolio hit very badly during the last market correction. This does not make all PMS products bad. The PMS products that got hit very badly were the ones that invested in high-risk small cap portfolios -- which tanked during the market correction. Good PMS managers that invested in large liquid stocks and managed risk sensibly have done very well.

Again, it depends. The fee structure of PMS is either or both of a fixed fee and a variable fee. The fixed fee, like a mutual fund expense ratio, is a percentage of assets under management. The variable fee is a profit sharing fee -- if your portfolio does well, the PMS shares in the profit.

While the fee structure of PMS may seem higher, individual clients can work out a fee with the manager that suits their needs. Often managers will give clients a low fixed and high variable fee -- which is a good alignment of incentives. The manager makes money, only if you do, unlike a mutual fund.

Selecting a PMS, like selecting a mutual fund requires a lot of careful judgement. There are some very critical factors to keep in mind while selecting a PMS:

• Check that the portfolio manager is a SEBI registered manager with a PMS certificate and registration number. Many brokers and wealth managers run illegal PMS operations where they pool everyone's money and manage it. Check the SEBI website for the list of registered PMS.
• Look for someone who has a unique strategy or style. It is no point getting into PMS if you are getting the same portfolio as a mutual fund.
• Work with a boutique fund manager if you are opting for PMS. Brokers and AMCs are the worst choices for PMS. Brokers are not professional fund managers and have an incentive to churn your PMS portfolio to earn brokerage. AMCs place their best fund managers on mutual funds (because they have a larger corpus), and PMS is often the ignored step-child. Work with someone whose bread and butter is PMS.
• Avoid managers who focus excessively on small-cap stocks. While they promise high returns in the good times, they sink quickly in the bad times.
• Check the track record or performance of the fund manager. PMS managers often claim performance numbers without a verifiable basis. Ask for an auditable track record -- one that can be certified by a reputed third party, such as a bank or custodian.
• Ensure the manager has a custodian and third party fund accountant. A custodian is an external bank or depository that ensures your money is in safe hands. A fund accountant is a third party that ensures the manager is calculating and billing fees accurately.
• Understand how fees are calculated, particularly profit sharing, because it is a very complex calculation. Profit sharing should be subject to a high watermark -- if a manager loses money they have to make it back the losses before they can charge fees. Ask the manager to discuss fee calculation in various scenarios.
• Ensure the manager is not churning your portfolio aggressively and making you pay excess brokerage costs and short term capital gains.
• Ask the manager for the other costs they are charging -- particularly brokerage. PMS managers are often sub brokers who share in the brokerage with the primary broker. What looks like a cheap product on management fees will end up being absurdly expensive because you are being billed a very high brokerage rate. Be particularly wary of brokers and sub brokers who are PMS managers.

What should you choose? As always choose something that fits your needs, and more importantly, when making a choice, make an informed and careful one.