Differences between a PMS and a Mutual Fund

What are the differences between a PMS and a Mutual Fund?
There are two broad options to you as a new investor – you could invest in mutual funds (MFs) or have your funds in a “PMS”.

You can technically invest any amount you like in a MF [1], but you need to be ready to commit at least INR 25L for a PMS. SEBI put this guideline into effect in Jan 2012. As of now, any fund manager offering a Portfolio Management Scheme (PMS) must not accept sums lesser than 25L. SEBI’s objective is to ensure that only those who can “comfortably” set aside this large sum of money [2] would pursue separately managed accounts.

If you set aside 25L to a PMS, it implies (typically) that you will have to create a new demat and bank account under your name, with 25 Lacs (or applicable amount) from you deposited in the said bank account, and “ready” for the fund manager to deploy as s/he sees fit at that point in time.[3] The fund manager is authorized, by virtue of your signing the PMS management contract, to trade on your behalf, in your account. His goal is to increase the networth of that account of yours over time (ideally a long period of time). In between, you may make withdrawals if you must, so long as the account does not go below the 25L threshold. Ideally, you are not expected to use this as your checking or current account – this is the “fill it, shut it, forget it” account – as long as you are fine how it is growing.

Portfolio allocation & setup : The fund manager may elect to keep 60-70% of your account in Cash and invest only a third of the monies (if, for example, he views businesses as being expensive) OR he may go “all-in” and invest it all immediately – it depends on his view of the opportunity set he knows at that point of time. Each person’s account is different.

Let’s say he had invested 10% of his portfolio in company X, priced a year ago at 100. In the 6 months before you invested with him, this one company X “ran up” or appreciated considerably, to say 185. In the fund manager’s view, this is closer to where it ought it be (say 200) than when he bought it. In your PMS account, he may choose to only allocate 2% to company X. In a mutual fund, you will implicitly buy this company at 185 in the same proportion as the fund holds it – there is no choice about fine-tuning the position sizing and no way to avoid it. To extend this example of flexibility further, a company that was not in someone else’s PMS account a year ago may well be in yours. Your fund manager will make investment decisions at the time you start the account.

To contrast – what do you really own when you go buy a mutual fund?

Let’s say a particular mutual fund manages 1,000 crores in a portfolio of stocks. Let’s say they own 100 companies in their portfolio, equally weighted & they have no cash left to invest. This means the fund owns about 10 Cr of each of those 100 companies. You can buy a portion of this fund. Let’s say you have 10L to invest, and you invest it all in this fund, you will be given a 0.01% share of this fund – and you will be given a unique number (a “folio” number) representing that stake in the fund. And since the fund has 100 companies, your 10L of investment represents a Rs 10,000 ownership in each of those 100 companies. You implicitly own those companies by your owning a stake in the fund. You will “own” each of those 100 companies with a cost price equal to whatever their prices were on the day your 10L was invested.

PMS, being accounts that are separately managed for you, have greater flexibility on portfolio allocation. A seasoned and capable portfolio manager will be able to take advantage of this flexibility to create better portfolios for you (i.e higher risk-adjusted returns). A mutual fund cannot have this kind of flexibility – every investor in the fund owns the same portfolio of stock in the same proportion.

Alignment of Interests

A key area where PMS offerings differ from Mutual funds is in the Alignment of Interests. The fund managers’ interests tend to be aligned with existing and new investors in the PMS as a large chunk or proportion of their networth is invested in the same fund. You can always ask & ascertain this.

Further, PMS schemes are offered on a profit-sharing basis with hurdles and high-water marks. This means they don’t make take a cut of the profits until they’ve exceeded certain pre-determined gain / hurdle thresholds (8%, 10%, 12% as examples). If they have down years, they need to get back up to the highest point they reached earlier (the “high-water mark”) before being able to take performance fees again. This is not an “option” – thankfully, India’s regulatory body SEBI has mandated this investor-friendly behavior in PMS offerings.

There are some excellent mutual funds in India with a value investing focus, but in general, there are issues with how they are typically setup, how they are incentivized and function. Here are a few Issues that I see with Mutual funds in India.

 

1. Only technically. Mutual funds are normally used to SIP monies, i.e steady contributions from people’s paychecks. Most funds will accept lumpsums, but some have limits on how much money you can contribute on any single day. IDFC Premier Equity fund for example, only allows SIP based contributions and only “opens up” to lumpsums when overall market conditions are deemed “cheap” by the fund manager / AMC

2. Every country has an equivalent concept in place which the regulators oversee to make sure that only those individuals who have more liquid funds available and are able to psychologically bear what may be higher volatility ought to be able to invest in such accounts.

3. This is the typical “non-discretionary” PMS. Under a discretionary arrangement, you may ask the fund manager, for example, to not invest in alcohol or tobacco companies, however profitable or lucrative the opportunity. You will not have this choice in a mutual fund because you either buy into the fund or you don’t. Any fixed or variable fees that you’ve agreed to will be automatically calculated & deducted from your account. The same thing happens in a mutual fund, though it is “behind the scenes” as you only see one final number – the “NAV”.

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