How Sebi's tighter new rules protect PMS investors from mis-selling

The recent changes are also meant to reduce regulatory arbitrage between PMS and mutual funds

The portfolio management service (PMS) industry has grown at a rapid pace in recent times. The number of clients under discretionary PMS has doubled from 75,000 to around 150,000 over the past three-year-and-a-half years. Many new portfolio managers have also entered this arena. Instances of mis-selling of this product were also being reported. Hence, the Securities and Exchange Board of India (Sebi) has gone ahead and proactively tightened the regulations (they were notified on January 21) for what is becoming a crucial product in the portfolios of mass affluent and high net worth individuals (HNIs).

Minimum investment hiked from Rs 25 lakh to 50 lakh: The purpose behind this change is to ensure that only HNIs participate in PMS and not retail investors. The former are better equipped to handle the higher risk in PMS (owing to concentrated portfolios and other factors). The regulator believes that retail investors should stick to mutual funds, which are more tightly regulated to ensure investor safety.

Smaller clients within the PMS space will face the problem of diversification. With a Rs 50 lakh corpus, they could have achieved adequate diversification in mutual funds both in terms of market cap (large, mid and small) and investment style (growth, value, and blended). But in PMS they will be forced to invest the entire Rs 50 lakh corpus in one fund manager and one style.

Experts say PMS houses have a solution for this issue. "Many PMS houses have multiple investment fund managers, and each has his own approach. They offer the facility that your Rs. 50 lakh can be distributed among these different fund managers with varied investment strategies, so that you get adequate diversification,” says Pallavarajan R, founder-director, Pmsbazaar.com, a portal that provides PMS-related analytics and advice.

Investors should make sure that they have an adequately diversified mutual fund portfolio, and only then enter the PMS space. "Earlier, I would tell my clients that they should have a portfolio of Rs 1 crore in mutual funds and only then make their first investment of Rs 25 lakh in mutual funds. Now, I tell them that they should have Rs 1.5 crore in mutual funds and then take their first exposure of Rs 50 lakh in PMS. This is to ensure that their exposure to PMS is limited to 25 per cent of the portfolio," says Ankur Kapur, managing partner, Plutus Capital.

Nowadays, many advisors who hold an RIA (registered investment advisor) licence from Sebi, also offer stock advice. Investors who are unable to access PMS may use their services. Another option is to go for Smallcase, which allows investors to put their money in a wide range of investment portfolios catering to varied risk appetites.

Net worth requirement hiked from Rs 2 crore to Rs 5 crore: In August 2008, the net worth requirement was enhanced from Rs 50 lakh to Rs 2 crore. Now it has been revised again from Rs 2 crore to 5 crore. Existing players have been given 36 months’ time to comply. "Sebi has taken this step to ensure that the sponsor's commitment to the venture is more substantial," says George Mitra co-founder and chief executive officer, Fintso. This measure is also aimed at weeding out the less serious or fringe players from the arena.

No upfront fee can be collected from clients: The regulator had banned entry load in mutual funds from August 2013. Later, it also banned the payment of upfront commissions to mutual fund distributors and they were asked to follow an all-trail commission model. But this ban did not extend to PMS. So, PMS managers would charge what in industry parlance is called a set-up fee, which would be shared with distributors. As a result, distributors had become more interested in selling PMS products rather than mutual funds. It also created the incentive to mis-sell.

Experts believe this is a positive move for the industry. "It will lead to players competing on the basis of performance, and not on the basis of incentives provided to distributors," says Sushant Bhansali, CEO, Ambit Asset Management.

Discretionary managers barred from investing in unlisted securities: PMS products do not have a lock-in. Investors can redeem their money anytime (though they may have to pay an exit load in the initial years). This is unlike an equity-linked savings scheme (ELSS) in mutual funds that comes with a lock-in of three years, or an alternative investment fund (AIF) that could have a lock-in of five-seven years. “Unlisted securities tend to have low liquidity. If PMS managers invest in unlisted securities, they may have difficulty in meeting redemption requests from investors,” says Pallavarajan.  

However, Sebi has provided leeway to non-discretionary PMS managers to invest in unlisted securities up to 25 per cent of the client’s portfolio. In non-discretionary PMS, the portfolio manager only gives advice; he does not decide what to buy or sell. So, if a client sees good opportunities in the unlisted space, he has been given the option to invest up to one-fourth of his portfolio. It is expected that such clients would be aware that if they wish to exit from unlisted securities, they may not find ready liquidity and hence exiting could take time. 

Who should join a PMS and why

• You are a high net worth individual with adequate investment in mutual funds
• Now you want to invest in products with more concentrated portfolios that have the potential to offer higher returns
• You are an evolved investor who can tolerate the high volatility in concentrated portfolios
• In MFs, exit by investors during a market crash forces the fund manager to sell his quality stocks, which tend to be more liquid. This affects the quality of the portfolio
• PMS is not a pooled account. Your portfolio is protected from the behaviour of other investors
• PMS managers do not face restrictions on how much they can allocate to a particular stock
• Since their investors are more evolved, PMS managers face less pressure to perform in the short term and can take longer-term bets
• They can construct benchmark agnostic portfolios, which their more cautious counterparts can’t 
• Once you become a PMS client, you get more information than an MF client. You will know which stock was bought or sold in your portfolio, when, and at what price. MF investors only get month-end reports
• Portfolios can be more customised. If you already own pharma stocks, for instance, these can be removed from your portfolio