BackThe lure of portfolio management services
Mutual funds are for retail investors and their margins are getting tighter. To attract HNIs, and improve revenue, fund houses are looking at portfolio management
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As the norms around distributor commissions get tighter and margins of mutual fund houses reduce, fund houses have begun to look at other sources of income to keep their cash flows healthy. The share of portfolio management services (PMS) fees in their income went up to 6% for financial year (FY) 2015-16, as per a Mint analysis of 41 fund houses’ annual statements, based on Value Research data. In FY15, they had earned 4% of their total income from PMS. Broadly speaking, fund houses earn revenues from four sources: managing the money you put in mutual fund schemes, PMS, foreign advisory services and other income.
Portfolio management
A mutual fund vehicle is meant for retail investors and all its investors of a scheme have to follow a single strategy. Thus, fund houses find mutual fund schemes restrictive if they wish to attract high net worth individuals (HNIs). “A mutual fund scheme cannot hold a concentrated portfolio as there are caps on individual holdings. These restrictions are not there in PMS schemes," said Aashish P. Somaiyaa, managing director and chief executive officer, Motilal Oswal Asset Management Co. Ltd. Experts also claim that this club of investors typically likes to hold shares, and not just mutual funds.
In the PMS strategy, a fund house has several model portfolios. Then, when an individual walks in and subscribes to the PMS—typically with her own existing portfolio of direct equities—the fund manager remodels the existing portfolio and brings it as close as possible to the model portfolio of the PMS strategy that the investor subscribes to.
Commissions are high, and are said to go up to 5% upfront. Mutual funds can neither pay upfront fee in excess of 1%, nor trail fees beyond the total expense ratio, less upfront fees. Further, in March 2015 the Association of Mutual Funds of India (Amfi) laid down strict limits on how much fund houses can pay to distributors.
“But these commission guidelines don’t encompass PMS schemes," said the head of marketing of a fund house, who did not wish to be named. He said that if the fund house earns 2% management for a 3-year PMS scheme, it earns 6% in all these years. This fund house, therefore, can “afford to pay about 5% fees to the distributor, upfront."
Somaiyaa, whose fund house earned 63% of its FY 2015-16 income through PMS, agrees that PMS can pay high commissions to distributors but that’s not always the case and not the only reason why PMS sells: “Distributor commission fees may be high, but this depends on the expenses that we charge to the client—here it could get moved up or down a bit, depending on the investor, but nevertheless remains within a predefined band—and this in turn depends on the ticket size. As the ticket size goes up, the expenses we charge go down." To be fair, Motilal Oswal has been in the PMS business for over 13 years, while it started its mutual fund business only in 2010. It then transferred its PMS business into the asset management company.
Foreign advisory
Fund houses located in foreign countries can get in touch with agencies here—which are mostly Indian arms of international fund houses or other fund houses too—to manage the money that their investors wish to invest in India.
Typically, foreign fund houses in India manage the inflows that their parent company manages abroad. Close to 17 fund houses in our list had some percentage of their overall income coming in from managing or advising overseas assets.
“Spreads (income) are becoming thinner from the domestic mutual fund business. That’s why every fund house looks at ways to widen its revenue, within the asset management space," said Swarup Anand Mohanty, chief executive officer, Mirae Asset Global Investments (India) Ltd, whose fund houses earned close to 10% of its income from foreign advisory. Mirae Asset’s global investments in India are about $1.9 billion. Of this, Mirae Asset India advises on assets worth $500 million and earns a fee.
As the alternative investment funds (AIFs) space opens up, fund houses will look towards it too. Prashasta Seth, chief executive officer and fund manager, equity, IIFL Asset Management, said that although the fee structure in alternate funds is lower than that of a mutual fund, many funds enter into a profit-sharing agreement with their clients. This helps boost their overall income. The fund house earned about 50% of its revenues from the AIFs that it focusses on, including real estate. “It takes a long time to develop a mutual funds business for a new asset management company. It needs to have a track record of 3-5 years to get noticed. How does it sustain in the initial years then? The traditional method no longer makes us money for the first 5 years. But streams like AIFs help us earn revenues faster," said Seth. He added that the IIFL group’s internal wealth management division (“a significant chunk of our sales happen through here") caters mainly to HNIs who prefer high-risk, high-return products like AIFs.
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