Why PMS is suitable for HNI investors? A risk-reward perspective

India’s buoyant equity markets and start-up ecosystem have given birth to a class of wealthy individuals. Every time a start-up is listed, the focus is entirely on how the zooming valuations have led to massive wealth creation for the founders. However, little is talked about many C-suite employees, numbering anywhere between 40 to 100, who also make significant money in the process. These new wealthy individuals often look for advisory services that will not just manage their money and boost their portfolio with higher returns.  The growing class of new investors is looking for fund management services beyond the traditional investment approach such as mutual funds.

Portfolio management services could be the answer.

What is PMS?

Popularly known as PMS, portfolio management services offer tailor-made investment solutions based on the needs of high net-worth individuals (HNIs). To be sure, rich families and those with generational wealth are already availing PMS. The reason it is suitable for HNIs is because of the entry-level requirement or the minimum ticket size. According to rules of Securities and Exchange Board of India, investors need to invest a minimum of INR50 lakhs in PMS. Unlike mutual funds, which are more mass market investment vehicles for retail investors, PMS deploys a non-pooled strategy, combining expertise of skilled portfolio managers, stock pickers and a research team to identify alpha-generating stocks. However, investment is not just limited to equities but also includes other investment vehicles such as fixed income and structured products.

PMS is suited for investors with at least three years of investment horizon.

SEBI rules also mandate executing agreement and power attorney, which allows entities offering PMS to act on behalf of the clients. The agreement also spells out how much fees to be paid to the portfolio manager by clients.

There are two broad categories of PMS –

Discretionary portfolio management – Here, the portfolio manager is responsible for constructing and managing a portfolio which is best suited for the requirement of clients after understanding their objectives, risk tolerance, and investment horizon.  

Non-discretionary portfolio management – Under this category, the portfolio manager advises you specific investment style but the final decision is with the client. The manager makes a decision after getting a go-ahead with investors.

Fee structure–

Other than offering tailor-made investment solutions, what differentiates PMS from mutual funds is the flexible fee structure. Mutual funds charge fees in the form of total expense ratio or TER on assets under management, irrespective of the performance of the scheme. On the other hand, PMS has flexible fee models  

PMS offers better flexibility in terms of fee structures compared to mutual funds. While mutual funds charge TER on AUM irrespective of scheme’s performance, PMS offers some innovative fee models – either fixed amount, performance-based or combination of both. Moreover, SEBI regulations do not allow portfolio managers to charge any upfront fees, directly or indirectly, from clients. The agreement between the client and portfolio manager also details the fee structure, including the quantum of fees as well as payment for each service, thereby avoiding potential legal issues in the future.

A high-level of performance-based incentive rather than fixed fees makes PMS a result-oriented investment strategy. Many portfolio managers seek payment of fees only after passing a pre-defined hurdle rate. Hurdle rate could be a pre-defined rate or a minimum acceptable return. Returns of benchmark indices could also be a hurdle rate. 
Because the real incentive starts to trickle only after delivering results portfolio managers are motivated as well as have a skin-in-the-game to generate alpha or higher returns while staying on course of the client requirement.  This also ensures transparency.  

In fact, SEBI has mandated disclosure and reporting of key details to the clients. Some of them are as follows -

• Details and value of the portfolio along with description, value of each security 
• Date and details of buy and sell transaction 
• Any interest, including dividend, bonus shares, right shares, received during the reporting period 
• Expenses incurred in managing the portfolio 
• Details of any default in payment of coupons or any other default in payments in the underlying debt securities

Over the years, steps such as standardization of reporting and evolving regulations on operational aspects has not only ensure client safety but also led to product innovation that aligns with the growing demand of new wealthy individuals.