This article has been sourced from the September 2007 issue of Money Simplified NRI Investment Guide 2008.
Portfolio Management Schemes are hugely popular with investors these days. Interestingly, a large number of investors we meet at Personalfn are already evaluating an equity PMS opportunity, but usually for the wrong reasons.
Here are some of the key reasons we have encountered when discussing the investor's interest in equity PMS:
1. It's personalised
As compared to a mutual fund where an investor is one of hundreds of thousands of investors, in a PMS there is a select investor base. This permits the fund manager of the PMS to offer a more personalised service. From the investor's perspective, there is a lot more direct interaction with the fund manager and also customisation of his portfolio.
2. Offers online access & daily update
The PMS provides almost real time access to transactions undertaken by the fund manager. This access is available over the internet, or at times, over the mobile. As a result the investor 'knows' what is happening and is therefore at ease.
3. Opportunity to use advice for own portfolio
Since the information on what the fund manager is doing is made available almost real time, investors have the opportunity to replicate these transactions for portfolios that they still manage on their own. This is like an added benefit of doing a PMS.
4. Offers better returns
Finally, of course, PMS provides an opportunity to earn better than market returns. In fact, they deliver better returns as compared to comparable mutual fund schemes.
Prima facie all are valid reasons. But are these the reasons you should be investing in a PMS?
Well, when we evaluate an equity PMS, this is what we look at first:
1. Objective of the fund
- basically the mandate of the scheme i.e. the investment style that will be followed, where will the money be invested et cetera. Does this suit the needs of the investor?
2. The fund management team / fund manager
- who will manage the money? Whether it is a team, or an individual? In either case, what's their experience, and most importantly their performance in declining markets (in a rising market, the more risk you take, the more return you make. It's only over a stock market cycle that you are able to identify the smart fund management teams).
3. Performance of other PMS schemes offered by the same organisation, both managed by the same fund manager, if any, and others
- how the scheme under consideration, as well as the other schemes on offer by the same organisation, have performed both vis-à-vis its peers and its benchmark, on a risk adjusted return basis.
4. Fees (including trading costs)
- what is the cost of being invested in the scheme? Here we look at not only the entry load and the annual management fee, but also the profit share and, importantly, the brokerage cost (a lot of PMS providers have in-house brokerage houses and at times you are not sure whether the churning is for your benefit or their's).
Yes, the way we evaluate the PMS is quite similar to how we would look at a mutual fund scheme. But then, both instruments are similar in many ways.
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Notice, we do not pay much heed to most of the reasons which investors tend to give when evaluating the PMS. And you should not too. Let's discuss the evaluation parameters that we do not consider very vital.
Personalised service is a big scoring point over an alternative opportunity like a mutual fund. And indeed, some PMS providers do offer a genuine personalised service where the portfolios are customised to the needs of the individual. But then given the aggressive marketing of such services, and the low initial investment (usually between Rs 2.5 m and Rs 5 m; in some instances even Rs 1 m and less), the number of investors is bound to become unmanageable sooner or later. In fact in many instances, it already is. In such circumstances you run the risk of being invested in a portfolio which is not being managed the way it should be. So instead of working to your advantage, the "customisation" of your portfolio could actually hurt you over time.
The next point is a bit bizarre. Investors are actually giving money to a PMS just because they like the idea of having online access to their portfolios, on a day-to-day basis! We fail to understand how this delivers much value. In any case, an equity PMS is a long- term investment product and you should not be monitoring it every day!
Linked to the point above, is the advantage of using the advice for one's own portfolio. Well, if you have the time to monitor every move of the fund manager, and you are sure he is always right, then you might as well replicate all his transactions.
But if you are a person who is short on time, which you all probably are, then this opportunity does not really exist.
Finally, and most importantly, the better returns. In recent times we have met a lot of investors who are certain that their PMS investment has done very well. And they are right. But that's on an absolute return basis. Compare the performance with something as mundane as the BSE Sensex, and there is a fair chance you will be disappointed to see the relative performance of your PMS (return net of fees). Do two more tests - one, compare the performance to the better managed equity funds over a similar time frame, and, two, compare the risk adjusted return of the PMS and the better-managed equity funds. It is likely there will be some more disappointment. So, do not look at absolute return; evaluate vis-à-vis other opportunities, and adjust for risk for a meaningful evaluation of performance.
And this brings us to the point about fees. Most PMS schemes have a relatively complicated cost structure as mentioned earlier in this note - a one time up front fee, an annual management fee, a brokerage cost and also a profit share. Once you factor in all this, quite a bit of your overall profits get lopped off to the fund management company. You need to understand this very well before committing any monies to a PMS; and remember all these costs are generally negotiable!
This is not to say that all PMS are bad. Not at all. Some do merit serious consideration but as is the case with mutual funds, you need to be very selective and choosy when identifying your vehicle for investment.
To conclude, here are some more comments/questions you must discuss/ask when evaluating a PMS:
1. In instances where the PMS is customised and therefore unique to the individual, some PMS still show past performance to make their case. If the portfolio is indeed unique, then it has no track record, and therefore no past performance!
2. Is the past performance that is shown in the marketing literature by such PMS an aggregate of all portfolios, or of only the best performing portfolios?
3. If the past performance that is shown is an aggregate of all portfolios, then have the portfolios which are no longer in existence been included? This is important as at times the portfolios which are taken back by clients are the ones which are under performers.
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