Market regulator SEBI released a consultation paper on Portfolio Managers regulations last Friday. It is good time for us to take a holistic view of it. A Portfolio Management Service (PMS) is an organized approach to managing your portfolio of securities in which you continue to own the stocks, but there is a professional manager providing his/her inputs (advisory) or executing the advice (discretionary). There is an annual fee to be paid to the professional manager of the portfolio, which is over and above the operating expenses (custody/audit/miscellaneous) and brokerage on transactions.
Mutual Funds are regulated by the SEBI, and the regulations and supervision are relatively ‘heavy touch’ as against those governing the functioning of AIFs (alternative investment funds) or PMS. The reason for SEBI’s regulations being relatively ‘light touch’ in the case of AIF or PMS is the higher entry threshold—clients taking the services of a PMS are supposedly savvier, whereas mutual fund investors are more likely to be from the retail category. The savviness of a client cannot be measured or defined, but that of the provider can be defined in terms of qualification, net worth, experience, etc.
In any industry, mid-course changes to regulations in response to an evolving scenario is a normal, healthy process. In the case of PMS Regulations, the Working Group has put forth multiple recommendations, and the salient ones are detailed here.
Raising the bar
HNI clients, and not retail customers, would avail of PMS. They supposedly have a better understanding of what they are getting into. As the report says, the PMS industry has an AUM (assets under management) of Rs 18 lakh crore across 1.5 lakh clients. The average ticket size is more than Rs 11 crore. Hence, this new suggestion, if implemented, should not make much of a difference.
Enhancement of minimum capital adequacy to Rs 5 crore from Rs 2 crore:
More ‘skin in the game’ for the PMS provider would ensure only serious players offer the service. Some fringe players may find it tough, but in the overall interests of the industry, and the suggestion is desirable. A Principal Officer, a minimum of two employees and an enhanced eligibility criteria have been proposed. These will lead to better quality of service, as only serious players would be in the fray.
The ‘investment approach’, which may loosely be compared to the fund categories of Mutual Funds, would be used in PMS communication and reporting. This would give a better perspective to the client as to what she/he is getting into. There are certain investment restrictions put on the manager—for example, being allowed to invest only in listed securities (equity, debt etc.).
Currently, there is no standardization in reporting performance. Multiple norms have been proposed: for example,
– The performance reported by the PMS provider in its marketing material and website should match the performance reported to SEBI
– The combined performance of all the portfolios managed by the PMS entity should match with the aggregate performance at the PMS firm level
– Returns are to be calculated using time-weighted rate of return
– Performance is to be reported net of all fees, expenses and taxes
Uniformity and transparency are always welcome.
Costs have been rationalized.
– No upfront fee to be charged from clients
– Operating expenses, other than brokerage and annual management fees, capped at 0.50 per cent a year
– Exit load to be capped
– Client Agreement to contain separate disclosure of fees and expenses.
In MFs, the expenses that may be charged to a scheme are capped, and those include operating costs, transaction brokerage, etc. The ‘commercial arbitrage’ between MFs and PMS is being controlled, which is beneficial for investors, as it will reduce the skew in favour of PMS. Still, there is no cap in PMS offerings on the trail fee that may be charged.
To curb mis-selling, certain provisions on distributors have been proposed:
– Minimum eligibility for distributors
– Distribution commission to be paid only on a trail basis, similar to the way it’s done in the case of MFs
– Disclosure of fees to clients
– Self-declaration on non-mis-selling.
Ever since the curbs on distributor commission were imposed on the MF industry, there was a shift towards AIF and PMS, driven not just by the product proposition, but for better monetary benefits as well. As and when the contents of this consultation paper become rules, one loophole will be plugged. That will still leave out AIFs. Having said that, the ‘regulatory arbitrage’ between SEBI and IRDA is stark; insurance companies are in a position to offer handsome upfront commission to distributors.
In the final analysis, the purpose of the consultation paper is to seek comments/views from the public, prior to amendment of the regulations and making them law. Whatever changes take place, the intentions of the SEBI is to make them more user friendly by virtue of uniformity in disclosures, more viable by capping the charges and better distributed by virtue of some small measures to regulate distributors. While the SEBI is doing its job, you have to assess the value you are getting for the fees and charges and decide among Mutual Funds, ad-hoc broking services, AIFs and PMS offerings.