Budget 2024: PMS firms rethink strategy after increase in STCG tax

Churn in holdings will attract higher tax; no-pass through advantage like MFs, AIFs

The 33 per cent increase in short-term capital gains (STCG) tax, as announced in the Union Budget 2024-25, is likely to make it more challenging for portfolio management services (PMS) providers to compete with mutual funds (MFs) and alternative investment funds (AIFs).

While most PMS strategies focus on long-term investments, fund managers are used to short-term churn and agile sector rotations. However, such moves will now incur a 20 per cent tax, up from 15 per cent. Unlike the MF and AIF players, PMS providers do not benefit from a pass-through status, complicating efforts to outperform MFs and AIFs in terms of returns.

According to PMS firms, there will be an impact of the tax hike on short-term positions. They suggested a shift towards more deliberate long-term portfolio strategies.

“Churn does not get taxed in case of MFs, but it gets taxed in PMS schemes. We think it is inherently unfair, but we also understand why it happens. If you, as an MF industry, can churn tax-free, and for us, if the capital gains tax goes up, it creates an issue. But post-tax returns from PMS schemes and MFs don’t fundamentally differ,” said Saurabh Mukherjea, founder and chief investment officer at Marcellus Investment Managers.

While taxation is a crucial factor, industry players emphasise that achieving strong returns and making accurate investment decisions take precedence. Given the current market frenzy, with stocks yielding 50-60 per cent returns within a year, clients may still prioritise profit-booking despite the increased tax burden, they said. PMS funds, which target wealthy investors, aim to generate an alpha of 10-15 per cent.

“The differential in taxation is challenging, but we are still in a nascent stage of evolving as a financial product. In this process, weaker hands will probably move out of the industry. The better and stronger ones will continue, and the industry will go through a certain amount of consolidation. If one is good at generating risk-adjusted returns, you will continue to attract investors,” said Aniruddha Naha, CIO-Alternates at PGIM India MF.

Bhavik Thakkar, CEO of Abans Investment Managers, noted that tax implications are not always the primary consideration in a fund manager’s decision to sell a security. “It is more to do with whether the fund manager thinks he/she should be or not be in a particular stock. At the same time, what might happen is that fund managers will be more cautious in terms of checking what taxation implications there are for a particular stock, whether you’ve been holding it for more than or less than one year.”

The PMS industry is already facing challenges with the move towards a new investment vehicle proposed by the Securities and Exchange Board of India (Sebi), which shall feature a minimum ticket size of Rs 10 lakh, significantly lower than the Rs 50 lakh threshold for PMS. Although there is some ambiguity regarding the treatment of this new asset class, it will offer more flexibility than the PMS structure. For instance, PMS funds can use derivatives only for hedging purposes, whereas the new asset class allows for derivatives exposure beyond hedging, providing greater flexibility and risk-taking opportunities, potentially leading to higher returns.

“A lot of people who would ideally have graduated from an MF to a PMS will now have a smaller step where they can gain experience and move to a PMS,” Naha added.