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A senior executive with an information technology company had a sizable corpus from the sale of home properties he had invested in over the years. He decided to invest in equities and sought the services of a Portfolio Management Services ( PMS) entity. He was advised to invest his money in blue- chip stocks.

While this sounds prudent, the investor was not happy. He felt for the fees he was being asked to pay, he should have got better advice. After all, investing in blue chips is something he could have done himself, since he already has some understanding of equity markets.

No doubt, the investor can invest in blue- chips on his own. But a fund manager's expertise will help in stock selection ( not all perform well all the time), in knowing how much money to allocate to which stocks on an on going, dynamic basis and for risk management ( selling as and when the stock declines). A portfolio manager will look at the investment dispassionately and sell when the market is undervalued. Most investors don't do that and continue to hold dud stocks in their portfolio.

What is it?

By regulation, the minimum amount required for investment in a PMS is ₹ 25 lakh. Typically, the sizes can be ₹ 50 lakh to ₹ 1 crore. Such clients are high net worth individuals. These schemes are not publicly advertised products, unlike mutual funds (MFs). They are sold on a one- to- one basis. PMS funds have to report their investments every six months to the Securities and Exchange Board of India (Sebi).

PMS is basically a platform which can be used to implement customised strategies, unlike MFs, where there are clear guidelines. PMS allows more flexibility to a fund manager. For instance, if a manager has a strategy of investing in no more than eight or 10 stocks, it will be possible under PMS but not under MFs, where there will be a limit on exposure to individual stocks. Or, the client might say he wants to focus on 10 stocks with a three- year perspective but does not want any stock which is likely to see the impact of currency fluctuation. In a PMS scheme, the fund manager has some ability to influence the client and convince him to stay invested for a three- to- five year period if, for instance, the objective is to invest in beaten- down stocks.

It is possible to offer a customised and flexible strategy to clients under PMS,.

While PMS funds are more flexible than MFs, there are some broad guidelines.

For instance, investment in derivatives is possible only for hedging and not for leveraging. PMS schemes can invest in equities, listed and unlisted debentures, exchange traded and currencies is not permitted.

All PMS funds have to file a disclosure document before launching. This will include the objective, investment strategy and any limit laid down by the fund manager. Approval by Sebi for the disclosure document is not required for launching the scheme. After filing the document, if the regulator does not raise objections for a period of three to four weeks, the fund can go ahead.

There are two sorts of PMS. One is nondiscretionary, where the fund manager has to take the client's approval for every buy and sell decision.

And, a discretionary PMS, where it is left to the discretion of the fund manager.

Usually, the bigger investors prefer the non- discretionary PMS, while the smaller investors, who invest between ₹ 25 lakh to ₹ 1 crore, prefer the discretionary PMS. Also, clients who had a bad experience earlier with PMS prefer to be kept in the loop.

While it is not mandatory or required by regulation to do a risk profiling of the customers, most fund managers today do it. It is the norm.

Deciding

Before deciding which PMS scheme to invest in, investors must examine if they actually want such advice.

Since the record of such firms in India has not been very good, investors must confirm they understand the contours of the scheme before investing. Otherwise, they are better off investing in index funds or ETFs, which give similar returns at much lower fees. Usually, those who invest in such schemes don't have the expertise or time for investing.

In fact, Sharma advises before investing in a scheme, investors first look for cheaper alternatives, if there are some broad checks investors can do before selecting a PMS scheme.

Fund manager's record and past performance

Investors should look at the record of the fund manager for the past one to three years and also at the fund management team. Fund managers are on top of things happening and are looking at stocks as a fulltime job. There are cases where a stock moves anywhere between three and 10 per cent in a day and the fund managers can make money by selling stocks at the right.

Ask for disclosure document

These documents can run into several pages, maybe 40- 50, and they have details such as the investment objective, broad universe of investment, any limits such as exposure limits to individual stocks or risk management guidelines such as not having more than a certain percentage exposure to astock or keeping a certain amount in cash and so on.

For instance, a fund could have sub- limits such as not having more than 10 per cent of the portfolio in cash at any point of time or investing in mid- cap companies having turnover of ₹ 500- 1,500 crore and so on.

Ask for regular portfolio statements

By Sebi requirements, PMS firms have to disclose their portfolios only once in six months. But many send regular statements to their clients. Some give their clients an online login, using which the investor can look at the performance and holding on a regular basis

Regular portfolio review and meetings

The fund manager should hold regular meetings with clients, either on a one- to- one or common basis. Since PMS funds are customised products, they call for greater review. So, clients must ask for such meetings.

With service, disclosure or returns. Since it is a specialised and customised service, the expectation is that the returns should always beat the benchmark. So, if a client is not happy with the service ( not getting reports on time or not getting the desired level of transparency), he can ask for a clarification.

Clients can also watch out if the manager is churning too aggressively or too frequently because this will push up the brokerage charges.

If the fund manager deviates from the investment objective stated in the document or takes more risk, that can be a reason to worry. You can complain to the firm or even to Sebi; the latter can ask for an audit of the portfolio.

There are cases where the regulator has fined managers for not sticking to the investment objective. The fund manager should be able to explain what was the due - diligence done for buying or selling any stock. For instance, stocks like Satyam or Financial Technologies saw a decline in values due to events that nobody could explain.

Registered PMS firm

By Sebi guidelines, to get a PMS licence, a firm should have a net worth of at least ₹ 10 crore and people such as a Principal Officer, Portfolio Manager and Compliance Officer. The licence is awarded for a three- year period, after which it has to be renewed. So, before you commit your funds, check for all this.

Fee structure

There are no guidelines for this and it is left to the discretion of each entity. Most PMS firms offer a combination of annual fee plus profit sharing or annual fee alone. Very few charge fees as only a share of profit. In case of profit share, it can be either linked to a hurdle rate ( the client has to share profit only if the fund makes a certain amount of gains) or be fixed.

Taxation Since all securities are in the names of the clients, the taxation will depend on how these are treated. For instance, it can either be business income ( in which case you can set it off against expenses) or income tax (in which case, you can claim long- term capital gains tax exemption).

The most important thing for investors is to choose an investment which meets the objective and where one will be happy to lock in funds. Since most PMS have exit loads, investors must be prepared to do so, Mishra adds.

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