A new asset category proposed by the market regulator could transform the wealth advice business by giving advisers a direct way to collect fees, but stringent compliance norms and the net worth threshold could keep small advisers away.
Investment advisers, mutual fund distributors and even asset management companies plan to enter the newly announced mutual fund-only portfolio management services (PMS) category.
The Securities and Exchange Board of India (Sebi) has now proposed a mutual fund-only PMS with a minimum investment of ₹25 lakh, creating a middle path between basic mutual funds and standard PMS offerings that have a high entry threshold. Under this framework, PMS managers will build and manage portfolios of mutual funds instead of individual stocks, with investments made through direct plans rather than regular plans.
The proposal hits each intermediary differently. For MFDs, it creates another product that can be offered to clients alongside traditional mutual fund distribution. But for RIAs, it could solve one of their biggest problems: collecting fees from clients.
RIAs have been reeling under heavy compliance and restrictions for doing business, which have kept their numbers below 1,000 in India. Under the current RIA model, advisers have to bill clients separately for advice provided. This is unlike the commission-led model where the MFD gets its fees directly from the asset manager, which is deducted from the money invested by clients.
Fee collection
For RIAs, advisory fees are paid separately and directly by clients. However, advisers often face delays in fee collection or instances of non-payment, making revenue less predictable. An investment adviser with a very large practice may spend almost half a year only collecting fees and following up with clients, said Amit Sahita, director at Fincode.
“Fee collection in a PMS model becomes easier. Instead of operating purely as an RIA, an adviser could manage a client's mutual fund portfolio under a PMS structure, where fees are deducted directly from the investment corpus,” Sahita said.
If a client invests ₹25 lakh in a mutual fund PMS that delivers a 10% annual return, and the portfolio management fee is 1% of the initial capital, an amount of ₹25,000 will be deducted as the fee.
However, experts said stringent compliance requirements may be a pain point that may allow only a few RIAs to shift. PMS will likely have a higher compliance burden than that in the RIA model because managers have direct control over client money and are subject to more stringent reporting requirements to Sebi, said Abhishek Kumar, an RIA and founder at SahajMoney.
Even AMCs want to enter the segment. Kotak Mahindra MF offers fund of funds mutual fund schemes across debt, equity and precious metals. The same expertise can be offered under PMS if clients require the same, said Nilesh Shah, managing director at Kotak Mahindra AMC.
Vivek Vasudevan, co-founder and CEO of Agreya Capital Advisors LLP and a member of the board of the Association of Portfolio Managers in India (APMI), said the MF-only PMS structure is a definitive indication that Sebi wants to democratize PMS for everyone.
However, the entry threshold for investors could be lowered to ₹10 lakh from ₹25 lakh. The product is tightly controlled and only MFs, exchange traded funds and specialized investment funds can be offered. So, there are no unknown portfolio construction risks, Vasudevan noted.
Wider participation
To encourage AMCs and independent advisers to offer the MF only-PMS, Sebi has lowered their minimum net worth requirement to ₹2 crore from ₹5 crore and has made dedicated institutional dealing rooms optional. Vasudevan said the threshold net worth requirement could be made ₹1 crore to encourage wider participation from the RIA and MFD community.
In its consultation paper, Sebi capped the fixed management fee at 2.5% of the client’s assets under management per year and allowed an option to charge performance fees.
Manmeet Singh Khurana, founder of Wealth Dopes and a MFD, said the MF-only PMS might not offer a tangible differentiation because the gap between direct and regular expense ratios is already reducing and a blend of equity and debt schemes on an individual level further lowers the weighted average expense ratio.
Khurana said that in addition to this, if a performance fee is charged, it might completely relinquish the gap. On the contrary, managing a MF portfolio the PMS way could see excess churning to cover up for muted performances, resulting in exit loads getting triggered and reducing portfolio age, which is the most important variable for compounding.
Given the applicable net worth and compliance requirements, smaller distributors and RIAs are more likely to partner with an existing PMS provider as independent fund managers under the proposed framework than set up their own mutual-fund-only PMS, said Harsh Roongta, founder of Fee Only Investment Advisers LLP, a RIA.
Larger distributors and RIAs that have the scale to launch a PMS already offer advice or distribution across both direct equities and mutual funds. Even for them, partnering with an established PMS house as an independent fund manager may be more commercially viable than obtaining and operating a separate PMS licence.