Exploring the PMS World

Overhaul of PMS regulations

Over the last couple of years, the regulatory direction has emerged increasingly clearly. SEBI, RBI and the Government are tweaking and tightening in tandem, rules and regulations relating to trading and its financing and  taxation to contain speculative excesses and the concomitant losses incurred by the overwhelming majority of retail traders in the derivative segment of the secondary market. Simultaneously steps are taken to deepen and broaden the basket of investment products available to the entire gamut of investors. In the latest such initiative taken up in September 26, SEBI has brought about significant changes in the PMS (Portfolio Management Services) regulations.

Given that the Assets Under Management (AUM) of the PMS industry have grown at a CAGR of 13% over the last seven years and currently they stand at Rs 45 lac crores, which is almost half the AUM of mutual fund industry, a need was felt to increase the reach of PMS products in a changing milieu with competing, new and emerging products like SIF (Specialized Investment Fund) and AIF (Alternative Investment Fund). The most significant change in the regulations is the creation of a new category of PMS players through Portfolio Management Route for Investing in Mutual Fund Units (PRIM). With Mutual Funds becoming the primary vehicle for savings for most mass affluent investors, there was a need to make PMS affordable to this cohort, so that they can manage their fund portfolios better. SEBI is trying to cater to this demand, creating a new category of portfolio managers who manage only direct plans of mutual funds including index funds, exchange traded funds and specialized investment funds. The minimum investment for this route is lower at Rs 25 lacs compared to Rs 50 lacs under regular PMS schemes. The management fee in PRIM is also lower at 1% of AUM, though profit sharing arrangements are permitted.

PMS Industry

But before we delve deeper into the world of PMS investments, it might be helpful to revisit PMS basics. PMS is a separately managed portfolio as opposed to units in a pooled fund, where the actions of some unit holders in the pooled fund could affect the fortunes of other unit holders remaining invested in the fund. An example that readily comes to mind in this context, are the travails of the Franklin India Ultrashort Bond Fund before it was finally wound up. PMS on the other hand provides direct exclusive ownership, as securities are generally held in investor’s dmat account and cash remains in a designated bank account.

PMSs are broadly classified as:

Discretionary: The manager makes and executes investment decisions on behalf of the client.

Non-discretionary: Transactions require client approval

Advisory: The manager provides advice, while the client, takes and executes investment decisions.

Performance of PMS Schemes

Wading through the PMS world could be as, if not more challenging as wading through that of mutual funds. The Association of Portfolio Managers in India (APMI) lists about 1570 PMS strategies, including active and inactive offerings. PMS managers have greater freedom to run concentrated portfolios, although sustained benchmark outperformance has varied across strategies. A recent analysis of 554 active PMS strategies by Businessline shows that category average returns beat the relevant benchmarks in three out of six equity categories examined over five years. Midcap stood out as a challenging segment as no strategy managed to surpass the Nifty Midcap 150 TRI. Multi and Flexi cap strategies stood out with 2 out of 3 strategies in the sample beating the Nifty 500 TRI. The wide gap between category averages and the best performing mangers carries one more important message. PMS investing, at least at present, is primarily a manager selection decision, not merely a choice between strategies. The findings of Businessline analysis are summarized in the table below. Performance is reported using Time Weighted Rate of Return, which is designed to separate the manager’s investment performance from the timing of client’s cash flows (see the note at the end). The performance is net of management fees but without reckoning with investor level capital gains tax.

Evaluating PMS Schemes

1. Returns after all costs.
   Compare the performance after management fees, performance fees, operating expenses and transaction charges. A strategy that marginally beats an index before these deductions may leave the investor worse off than a low-cost passive alternative.
   
2. Prefer consistency:
   A 5 year CAGR can be dominated by the starting and ending dates. Try and examine rolling 3 year and 5 year returns, the proportion of periods in which the strategy beats the benchmark and whether outperformance persisted under the same portfolio manager and investment process.
   
3. Measure the pain:
   Maximum drawdown, downside capture and recovery time reveal risks hidden by an annualized return. A concentrated strategy may outperform over a full cycle yet expose the investor to losses that are difficult to tolerate or recover from.
   
4. Check concentration, turnover and category drift:
   Study the top 5/10 holdings, sector concentration, cash allocation and annual portfolio turnover. Also check whether the prevailing portfolio still resembles the stated strategy. A product labelled small cap, multi asset or debt may have materially changed its exposure over time.
   
5. Assess the manager, not just the strategy name:
   Confirm who generated historical record, whether the same person continues to manage the strategy and whether the investment process is repeatable. A good ranking becomes less relevant after a manager change, a sharp rise in assets or significant alteration in the mandate.

Note on TWRR:

TWRR breaks the investment period into sub-periods whenever money is added or withdrawn. It calculates each sub-period’s return separately and compounds the results. This removes the effect of the timing and size of external cash flows, making it useful for comparing performance of managers and against benchmarks.

Consider an account funded with Rs 50 lakh on January 1. It is worth Rs 49 lakh before another Rs 20 lakh is added on March 1. It rises to RS 75 lakh before Rs 10 lakh is withdrawn on October 1, and ends the year at Rs 70 lakh. The three sub-period returns are – 2%, about 8.69% and 7.69%.

Compounding the unrounded return factors gives a TWRR of about 14.7% as shown below: