For an individual investor, other than equity mutual funds, there is also an option to invest in portfolio management schemes (PMS) for their equity allocation. MF fees are regulated, and the structure and limits are defined by the regulator. On the other hand, PMS fees are more market driven for structure and limits. There is a third alternative—alternate investment funds (AIFs)— but at ₹ 1 crore minimum investment, these are accessible only to a few.
What you pay matters to the net return you make, so a cost comparison is part of the process while selecting any financial product, including managed equity funds.
Among MFs, equity funds charge the highest fee, which typically aggregates to 2.5-3% per annum for most schemes. As the scheme's corpus increases, as per regulation, the aggregate fee charged as a percentage of assets should reduce.
In PMS, too, the basic fixed fee is 2-2.5% per annum, but the flexibility is driven by the size of individual accounts through mutual agreement. “In the mutual fund structure, since there are no share classes permitted, an investor with, say, ₹ 10 crore will pay 10 times more absolute amount of fee compared to one who invests ₹ 1 crore as the proportionate fee remains the same for all. In PMS and AIF, there is an ability to calibrate costs for individual investments as the investment size increases," said Aashish Somaiyaa, chief executive officer, Motilal Oswal Asset Management Co.
For example, someone investing the minimum ₹ 25 lakh in a PMS may have to pay a 2% recurring annual fee, whereas a Rs5 crore investor in the same PMS strategy may pay a lower fee thanks to the bigger lump sum. Theoretically, this fixed fee in PMS can be agreed at close to zero for very large accounts. In MFs, a fixed fee percentage applies to all, and negotiations are not possible at an individual level.
The MF direct plan does offer a lower cost alternative. Direct plan fees are lower than the regular plan by 0.5-1% in equity funds. Direct plans are also the appropriate option for investors being advised by fee-only Sebi-registered investment advisers.
Apart from the annual fixed fee, MF investors don't have to bear any other expense. PMS investments often also have performance-linked fees or a profit share. This applies when the gains cross a predetermined level. For example, at the start of the PMS investment, the hurdle rate can be set at 10-12% annualised return after three years.
“Many high net worth investors now go for direct plans in mutual funds. In PMS and AIF, there is a fixed fee plus performance-linked fee which can ultimately make the cost higher. So for plain long only investing MFs may be a cheaper option," said Munish Randev, chief investment officer, Waterfield Advisors.
Performance-linked fee is considered an incentive for the fund manager to exceed benchmark returns consistently and by some margin. This can be advantageous for both the manager and the investor in a bull market. But in such a profit share arrangement, the downside is borne only by the investor. While it is important to analyse costs for product selection, factors like portfolio structures, investment universe, management experience and credibility are also relevant along with your ability to select funds and take on risk.