‘In the PMS fact sheet, see also the expenses incurred by the provider’

What do you attribute to the growth in the PMS industry in 2021?

What is happening is that structurally most Indian households are shifting their savings from physical assets to financial assets. As a result, whether it is a bull market or a bear market, flows into financial products are incredibly strong in India.

Mutual funds are becoming a mass-market product for middle-class investors who can, say, save 5-25 lakhs per year.

At the other end is AIF for ultra-high-net-worth investors (UHNIs), who have several crores of rupees to invest in a year. Between the two lies the PMS sector, which is becoming the vehicle of choice for HNIs who can save 50 lakh- 2 crore annually.

What factors should an investor consider before choosing a PMS manager?

Be it PMS/AIF/Mutual Funds, investors should look at three things. First, how much skin does the fund manager have at play—what percentage of his money is invested in that mutual fund or that PMS; the second is the expense ratio of that product; and third, track record of PMS or AIF or mutual fund.

Investors who are new to this industry can go to a high street bank and talk to the wealth management desk, which will have this data for PMSE as well as AIFs and mutual funds.

So what is the ideal skin in game percentage, expense ratio and track record?

Ideally, the fund manager’s entire net worth should be invested in the investment product he is managing. With regard to the expense ratio, the ideal situation is that the fixed fee should be close to zero. The only fixed expenses that investors must bear are fees such as custody fees and fund accounting fees, which should be some basis point of the cost.

When it comes to length of track record, I recommend that investors look for a track record of at least three years.

Should investors not consider performance figures at all?

The three factors I mentioned earlier can weigh 90% in deciding which PMS an investor should choose. The backward-looking returns (also called “track record”) should be only 10% of the decision-making algorithms.

As we have shown in our 2018 ‘Coffee Can Investing’ book, most equity mutual funds in India that outperform in three-year blocks tend to underperform in the next three-year blocks. Hence, very little persistence exists in terms of returns – be it PMS or mutual funds. Therefore, this tendency to look at historical returns and jump up and down has its limits.

In terms of returns, the Securities Exchange Board of India (SEBI) had revised the performance reporting standards for all portfolio managers in 2020. How has this significantly changed the way disclosures are made?

As per SEBI, when we report the performance, we should pull together the assets of all the clients, and the return is furnished from time to time covering all the charges and expenses. What PMS Manager cannot do is be selective. For example, the PMS manager cannot say that I will only take the XYZ portfolio and exclude the ABC client’s portfolio.

The standardization of performance reporting in the PMS industry has made the product more investor-friendly. If you look at the influx of the PMS industry after the January 2020 regulations, there has been a significant increase in them.

In case of an existing PMS investor, what kind of discussions can investors have with their portfolio manager?

As per SEBI norms, the entire portfolio of PMS should be disclosed to the investors every quarter. If you are an investor, you should not only look at the raw return or relative return, but also the expenses incurred by the PMS provider. If the expenses seem excessive, say anything north of 2%, the investor should call the PMS provider and try to understand what is going on.

And remember, expenses aren’t just fees; These include other ancillary expenses being borne by PMS, such as brokerage costs, custody costs, and so on.

Secondly, look at the extent of churn in the portfolio. If the portfolio is being churned by 20-30% every quarter, then in a year the entire portfolio is churned. And again, that’s something to discuss with the portfolio manager.

Lastly, see how many stocks held by the fund manager have performed well and how many have not in the last 12 months. Typically, 30 to 40% of the stocks in a well managed portfolio will be performing really well. It is therefore important to have a portfolio where the returns are relatively well distributed across stocks, rather than skewed towards one or two stocks.

As a result of this churn, PMS investors are paying capital gains tax despite no cash inflows. Do you think this is hindering the convenience of PMS investors from the compliance point of view?

The only type of fund structure in India where churn is not taxed is Mutual Funds.

Whether it is an AIF or a PMS or indeed a mutual fund, a low churn investment strategy reduces brokerage costs and reduces tax incidence for investors. And hence, more savvy investment managers in India tend to have less churned investment strategies. High churn also creates tax incidence.

From the perspective of capital gains tax complexity, you will find it difficult to find a simpler construction than the existing PMS constructions in India.