Those who plan to invest in stocks and bonds through a portfolio management service should be aware of its salient aspects and how a PMS is different from mutual funds and alternative investment funds. Here are the key features of investing through a PMS.
Model portfolio and customization
A provider of portfolio management services (PMS) doesn’t operate as a mutual fund or alternative investment fund would, managing a pool of money for investments in shares and bonds.
Instead, each PMS portfolio should be unique as it is supposedly curated by the provider for the client/investor. However, it is not possible to run exclusive portfolios for each investor. That would involve tracking too many stocks and bonds as well as many different portfolios.
What PMS providers typically do is run a model portfolio and replicate it for all clients. Individual client portfolios may vary from the model, but only marginally. In that sense, it operates like a fund with a manager investing a client’s money in stocks or bonds as per the mandate and runs similar portfolios for all investors.
Taxation
For taxation purposes, a PMS is called ‘pass through’—that means a client invests directly in those stocks/bonds. A PMS provider is not a separate entity for taxation purposes, as in the case of mutual funds. The usual rules of taxation apply for those securities.
As an example, listed equity stocks held for less than a year are taxable at 20% plus surcharge and cess. For a holding period of more than one year, the tax is 12.5%. For listed bonds held for less than one year, capital gains tax is applicable at the investor’s marginal income tax slab rate, and for a holding period of more than a year, it is 12.5%.
Mutual funds don’t pay tax because they are tax-free trusts. Tax is applicable for unitholders (investors). When a MF scheme books profit in a stock or bond, it does not pay tax, and the profit remains in the NAV (net asset value).
When the unitholder redeems an investment, tax is applicable. This differential between taxation of a PMS and an MF becomes more pronounced when an instrument is held for less than one year, as the tax rates for short-term and long-term holding are different.
Liquidity
In a PMS, when an investor requires liquidity, an instrument has to be off-loaded in the secondary market. The applicable tax would depend on the period of holding—long or short term. If there is a lock-in clause of say, one year, you would not get liquidity in that phase. If there is an exit load, that penalty would be applicable.
Flexibility
PMS regulations are more relaxed than those of MFs because it is not a mass-market product. In a MF, the maximum exposure per instrument is 10% of the portfolio. In a PMS, there is no such limit. Hence, it is possible to run concentrated portfolios in PMSs. We have discussed customization earlier, which is possible only in a PMS.
Ticket size
In a PMS, the minimum ticket size is ₹50 lakh, but the provider may ask for more in the form of cash, securities or a combination of both. If the PMS provider runs model portfolios in different asset classes, it is possible to have portfolio diversification within the minimum quantum.
If the provider has expertise in equities and bonds and requires ₹50 lakh, you can mandate ₹30 lakh in equities and ₹20 lakh in bonds. Or the allocations can be among various equity strategies of the same provider.
Costs/fees
Apart from the fixed fees, referred to as management fees, there may be profit-sharing. Beyond a certain defined level of profit in a financial year, called the hurdle rate, the returns may be shared between the investor and the PMS provider.
If the hurdle rate is 12% and profit-sharing is 80:20, then returns beyond 12% in a year would be shared in the ratio of 80% to the investor and 20% to the provider. Brokerage expenses for transactions in stocks/bonds may be charged separately.
Every investment option has its pros and cons. You can weigh the options—discretionary PMS (where the fund manager decides), advisory PMS (you pay the fees, take advice and invest yourself), MFs and AIFs—as per your suitability.
Joydeep Sen is a corporate trainer (financial markets) and author
