Should you be considering portfolio management schemes as investment options?
Once the Direct Taxes Code (DTC) is implemented (likely to be from next year, as promised by the the government in its Budget this year), mutual funds would lose their tax advantage. You can bet that agents of stockbrokers and funds would thrust portfolio management schemes (PMS) at you. Should you be considering them as an investment option?
I have been trying to get together some documentary proof on performance of PMS, in Indian equity markets. I get mixed feedback. A reasonable expectation to have is that PMS will deliver better returns than mutual funds. The handicaps that an investor has to overcome are:
The tax impact: MF gains are generally tax efficient. In PMS, you will pay short term/long term capital gains, depending on the churn that the fund manager has done. Typically, in a broker-managed PMS, you will have a high churn, so most of the gains would be subject to your marginal tax rate. So, a PMS has to match the mutual fund on a post-tax return basis. In short, it could mean that a 60% return in a mutual fund is the same as a 90% return in a PMS.
The cost structure: In a mutual fund, there are two types of costs. One is the AMC fee, that is restricted to 2.5% per annum of the value of your investments. In a PMS, these charges are contractual and could include the following:
Brokerage, at a rate that is above market rates are typically charged to a PMS scheme, since the broker is also the manager of the PMS scheme. In a mutual fund, unless the fund manager is personally corrupt, you should get a far lower brokerage charge.
The other thing that the PMS manager dobs you with is a ‘performance’ fee. This is the most obnoxious part, given the way it is structured. Typically, PMS is structured in a way that the manager shares ‘excess’ returns over a ‘hurdle’ rate. The ‘hurdle’ rate is typically a low number of around 10%-12%. In effect, last year, when the market returned 80% plus, a PMS manager would have minted money even if he had grossly underperformed the market. Even if he gave a 50% return, he would have earned a ‘performance’ fee on the returns in excess of the low ‘hurdle’ rate! So, after paying this fee and suffering tax, the actual return to you would have been pathetic! For instance, if the agreed hurdle rate is 10% and the sharing is 50% of the excess above ten, you would be in a poor shape. This is what your money would have done:
|Gross return, say||50%|
|Excess performance fee||20%|
|Your pre-tax return||30%|
|Tax (depends on the churn)||10%|
If your PMS delivered this last year, you have been had very badly. If you had put the money in a middling mutual fund, you would have got a post-tax return of 80% plus!
Of late, you would have seen the distributor pushing more and more PMS down your throat. DO NOT GET CARRIED AWAY. The distributor generally negotiates with the scheme manager to share anything between 50%-90% of the ‘performance’ bonus, in addition to a fat upfront fee. Since this is an unregulated space, the distributor makes money.
PMS is also used for manipulation of some stock prices. Since they do not come under any limits for holdings, it is easy to park shares in PMS. If an organisation has a set of investment companies, mutual funds and PMS, it becomes simple to manipulate stock prices. So, if you see some vague scrips getting traded/bought in your PMS account, it could be either because your fund manager has found a new investment idea or because the promoter or owner of the investment firm is using your PMS as a conduit for manipulation. Of course, since the objective of manipulation is to jack the share price up, you generally gain. Of course, when the game goes wrong, you end up picking the tab.
Once DTC kicks in, the mutual fund industry will also be taxed. It is likely that there would be no difference in tax efficiency inter se. In such a case, I can see a large shift from mutual funds to PMS especially on distributor push. It is likely that star fund managers will move to PMS rather than working for a mutual fund scheme.
So, what changes should the PMS managers do, before it suffers the same fate of economic closure by the regulator, as the mutual fund industry? To me, following changes are required in the PMS structure:
1. Details about fund manager, his track record and his involvement.
2. Past performance track record of the PMS scheme/s.
3. A hurdle rate that is also linked to an index return. For instance, the hurdle rate should be the lower of either the ‘index’ return on a pre-tax basis with a minimum positive number.
4. Disclosure of brokerage rates in the PMS schemes and a guarantee that the house broker will charge brokerage that is not worse than any institutional client.
5. A disclosure of portfolio on a monthly or quarterly basis.
I have seen mixed data on performance of PMS. Most have given returns worse than mutual funds. I have also seen a couple which have delivered far higher returns, but in each of the instances (where the PMS returns were higher), the PMS sponsor had outsourced the fund management to a third-party fund manager with a good track record. In one case, there is a professional fund manager, who manages PMS for half-a-dozen different entities on a fee basis. Most ‘brand’ name or institution-backed PMS seem to have done badly. My feedback is based on verbal conversation with investors. Of course, no PMS manager wants to make data available in the public domain for reasons yet to be fathomed.
PMS can be a very potent vehicle. With no single stock limits or sector caps, a smart PMS manager can deliver high returns. One other thing in a PMS is the issue of how customers in the same scheme are treated. Fairness demands that the portfolio of any two clients in any particular scheme should be identical. In real life, fund managers behave strangely. I have seen late entrants into a scheme getting a different portfolio. This happens when a PMS manager has made a choice in the scheme that has done badly and he does not have the courage to cut his losses. In such cases, he tends to avoid that stock in the portfolio of the new entrant. To me, this is stupid and wrong.
I also notice that many AMCs run PMS. In such cases, fund managers who run PMS have a tough call on their hands. In a mutual fund scheme, he is focused on the daily NAV rat race and in the PMS he has to deliver absolute returns. Relative performance in a PMS is obnoxious and is a poor excuse. A PMS should at anytime be in positive territory. The fund manager has the freedom to be fully in cash or refund the money if he cannot find winners. So, beware of PMS fund managers who show you ‘relative’ performance with negative numbers. PMS throws many challenges at a fund manager. Transparency from them will help.