Mutual funds (MFs) or Portfolio Management Services (PMS)? It is a perpetual dilemma for investors keen on high equity exposure. If you dive deep, there are data points in favour of both the options and at times, the clutter of information may confuse you further. However, to make an informed choice, looking at key metrics such as your tax liability, asset allocation and overhead costs, among other things, can help.
Multiple fund manager/fund house: When you create a portfolio using four to five MFs, you are exposed to multiple fund managers/ fund houses; however in the case of PMS you stick with a single fund manager or fund house, increasing your fund manager risk considerably, especially while investing higher. Multiple fund managers also help you experience different styles of investment management.
Taxation: In both MF & PMS the fund manager engages in buying and selling of securities depending on the market conditions. However, in PMS, the investor is liable to pay yearly capital gain taxes. In the case of MFs, this is exempt, and the investor is liable to pay taxes only when they sell their holding. Second, when you receive dividends for the securities you invested in a PMS, it is taxable as per your tax slab, but in case of MFs the dividend goes to the fund houses’ account, and is reflected in your NAV; which is not part of your income and hence is not taxable. Normally these cash outflows in the form of capital gain and tax on dividends are paid from the investors’ present income, hence when PMS firms declare their performance, these outflows are not considered and their performance looks better in paper. So, the actual investor returns differ with what you see in paper.
Asset allocation convenience: Whenever markets are high you can decrease your equity position and increase your debt/gold allocation and vice versa using the switch option. In the case of PMS, its only equities. So, your rebalancing strategies are complicated, Because of that, mostly you may skip doing it. It’s important to keep your money in debt funds which offer the highest safety so that you will be able to pump back to equity during a bear market.
It is not feasible for a small investor to do this, as there is a regulatory mandate of minimum ₹50 lakh in PMS.
Performance fee: PMS and MFs both charge approximately 1.5% per annum as management fees. The total assets under management being less in PMS, they usually go for performance fee for better profitability. This is usually charged only for the additional returns generated. If the returns generated are above 10%, there will be a performance fee of 10%.
In a year like 2023, where investors made 40% of returns, which is above 30% in addition to the huddle rate mentioned by PMS firms, a 3% (10% of 30) fees would be charged by the PMS firm in addition to the regular management fee of 1.5%. Hence you end up paying 4.5% fee in most good years. This is not applicable in MFs, since AMCs are only allowed to charge fund management fee.
Transaction costs: Though platform dependent, the transactions costs are generally higher for PMS.
Regulations: Sebi has designed MFs as an investment option for commoners, HNIs and institutional investors; whereas PMS has a minimum investment amount of ₹50 lakh, that makes it affordable to only those who can afford high amounts and those who can understand the risk levels in such an investment option. By design, the regulations laid out by Sebi are in favour of MFs than PMS.
Probability of outperformance: PMS fund managers are allowed to take concentrated portfolios, letting marginal outperformances compared to a MFs in short terms. In the long term the differences are minimal and the additional charges and disadvantages in taxation usually offset a major part of it as depicted in the above points. The marginal out-performance comes with a dis-proportionate increase in risk levels.
MFs are a far superior avenue for investors to take equity exposure.
Sibin Paul is founder and CEO at Wealth Metrics and an MFD.