How do portfolio management schemes work?

A portfolio management scheme (PMS) is like a mutual fund but for slightly larger investments.

Nov 30, 2018 04:11 IST India Infoline News Service

Portfolio Management
A portfolio management scheme (PMS) is like a mutual fund but for slightly larger investments. According to SEBI regulations, the minimum investment in a PMS should be Rs5 lakhs, although most schemes in India keep Rs25 lakhs to Rs1cr as the minimum cut-off. There is no upper limit on PMS investments. A PMS can only be operated by an authorized portfolio manager registered with SEBI. Such registered PMS services have to meet certain minimum standards of capital adequacy, mandatory disclosures, regular filings with SEBI, skill set requirements, and other standard operating procedures.
 
How exactly do PMS services operate in India?
 
Understanding PMS categories in India
 
Broadly, there are two categories of PMS in India: discretionary PMS and non-discretionary PMS. In discretionary PMS, the investments in equities and bonds are done at the discretion of the fund manager. The client does not get involved in the day-to-day decision making, but the client does have continuous access to the performance of the scheme at any point of time. On the other hand, there is the non-discretionary side of the PMS where the portfolio manager only suggests investment ideas. Whether to invest or not and when to invest rests with the investor. However, an absolutely non-discretionary approach becomes very difficult to operate and measure. Hence, in actual practice, what the customer does is to give a negative list of stocks to avoid and the fund manager goes ahead crafting the portfolio.
 
How do I participate in a PMS scheme? Should I bring in cash or should I bring in my contribution in the form of shares? In fact, you can participate either by putting the money in as cash or as shares. To begin with, you can pay the minimum investment in a PMS either by cheque, demand draft, or via RTGS transfers. All the three forms of payment are acceptable although most PMS schemes will insist on payment by cheque or RTGS to ensure that the account map remains with the PMS for all future transactions. The investor can also opt for the PMS by transferring his/her shares into the PMS account. Generally, the PMS will do a review and sell shares so that the portfolio is in sync with the benchmark PMS portfolio.
 
Under SEBI regulations, the investor will have to execute a PMS agreement with the service provider and also execute a power of attorney (POA) agreement for ease of operations. There is routine KYC documentation that is required, and a separate PMS demat account has to be opened. This is distinct from your existing individual demat account. Apart from resident Indians, NRIs can also invest in PMS after opening a PIS account with an authorized bank.
 
How exactly do PMS schemes operate?
 
This is an area where PMS differs from mutual funds. A mutual fund scheme will have one common portfolio and investors get proportionate units out of that portfolio. In case of PMS, the portfolio is unique to each individual, although it broadly based on the model portfolio. Normally, discretionary PMS schemes will ensure regular contact with the client, give them regular reports and analytics on performance, and also provide an online web-based access to the portfolio and various analytical metrics. For large portfolios above Rs1cr, the PMS will arrange for quarterly face-to-face meetings with the client and it can also be monthly in case of larger portfolios.
 
Costs and Taxation for PMS
 
All the charges are specifically mentioned in the PMS agreement, and hence, it is advisable to read the fine print and get the agreement vetted by a lawyer. Normally, PMS schemes will charge the client an entry load ranging from 3-4% based on the size of the corpus. In addition, fund manager fees are charged, which vary from 2-3% per annum and is debited to your PMS account on a quarterly basis.
 
Most PMS schemes also charge something known as “alpha compensation.” This is an additional profit sharing arrangement with the client if the returns cross a certain threshold. If threshold is 14% with 20% added sharing, then a return of 22% will mean that you pay an additional profit sharing of 1.60% (20% of 8%). This is over and above the management fee. In terms of taxation, PMS income has to be treated as business income or as capital gains because transactions are done through the client’s demat account. Chartered Accountants suggest using the business income reporting mode.
 
The PMS will also bill custodial charges, demat charges, audit fees, and brokerage charges on actuals. This adds up to quite a bit, hence, it must be ensured that your chosen PMS has a good track record and that you earn decent returns even after covering these costs.

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