Sebi likely to tighten regulatory framework for portfolio managers

Working group looks at improving disclosure standards, proposes scrapping of hurdle-rate for performance fee

The Securities and Exchange Board of India (Sebi) has received a string of recommendations from its working group on tightening the regulatory framework for the portfolio management service (PMS) industry.
 
One of the proposals pertains to increasing net worth requirement of PMS players to Rs 50 million.
 
Some of the other proposals involve improving the reporting disclosures, high exit-loads in PMS products and improving the overall industry standards.
 

The working group commissioned by the Sebi said higher net worth requirement would deter non-serious players while seeking registration and also put pressure on the fringe players. It observed that it has been over 10 years since the net worth requirement was last revised from Rs 5 million to Rs 20 million. However, the focus of the working group’s recommendations was to improve disclosures in the PMS industry, make it more investor-friendly and less expensive for investors.

 
The working group also took representations from the CFA Institute, which pointed out some issues in reporting or showcasing performance with both existing and prospective investors.
 
Some of the issues pointed out were PMS players showing returns on the basis of a model portfolio, excluding returns of investors that have exited (also known as ‘survivorship bias’) and disclosures not showing the impact of fees and expenses on the returns.
 
The working group proposed that performance should be reported net of all expenses and taxes. However, experts say even gross returns should be reported to give a fair understanding of the impact of fees and other charges.

 
“The gross returns don’t seem to have been included in the new proposal as the proposal says that all performance has to be reported net of all charges. Gross returns are also important for giving a fair picture of the performance,” said Sanjay Parikh, who has been leading the initiative in India to implement Global Investment Performance Standards that are formulated by the CFA Institute.
 
However, experts say some of the proposals can make a meaningful difference. “It is proposed that returns should be computed using the time weighted rate of return. Doing this will ensure that only real returns are reported, ignoring cash infusions or redemption by clients,” Parikh added.

 
Industry players add the proposal to adjust for returns of exiting investors is positive as it seeks to make sure that there is accurate representation of performance. “Typically, an investor exits a PMS-managed portfolio when he is disappointed with the returns. So, while giving financial year returns, the PMS provider should adjust for the exiting investors’ returns as well,” said Jinal Sheth, founding partner at Awriga Capital Advisors.
 
The working group also found that the exit loads levied on investors differ greatly from one PMS-provider to another. “Exit load ranges from 1 per cent to 8 per cent for up to 5 years. Exorbitant exit loads are not in the interest of investors or the industry. There is a need to standardise exit load structures,” the consultation paper read.

 
Moreover, the working group proposed scrapping the practice of using hurdle-rate to charge performance fees to  investors, but is looking at the ‘high water mark principle.’
 
According to this principle, the PMS manager can only charge performance fee to investors if the fund has crossed its highest value as on the day when the fee is supposed to be charged.
 
Interestingly, the consultation paper also proposes doing away with practice of giving upfront commissions to distributors, similar to Sebi's recent move in the mutual fund industry. Further, it proposed raising the minimum investment amount to Rs 5 million from Rs 2.5 million.