Performance matters: Why PMS may not be a great investment

Performance matters: why PMS may not be a great investment. (iStockphoto)
Performance matters: why PMS may not be a great investment. (iStockphoto)

Summary

The portfolio management services (PMS) industry, which caters to the investment needs of high net-worth individuals (HNIs), in India grew by about 14

The portfolio management services (PMS) industry, which caters to the investment needs of high net-worth individuals (HNIs), in India grew by about 14.5% last year, compared to a mere 5.7% growth witnessed by mutual funds (MFs) in the same period. The assets under management (AUM) of both PMS and the MFs stood at 26.9 trillion and 39.9 trillion, respectively, as of December.

However, the growth in the PMS industry that mandates a minimum investment of 50 lakh comes against the backdrop of its poor return performance compared to MFs, considered a mass product for retail investors (see graphic). This analysis is based on data from PMS Bazaar, a portal providing information about PMS funds in India.

There are about 400 asset management companies (AMCs), each offering numerous PMS strategies in the market today.

Over a 5-year period, only 30% of small-cap PMS funds could outperform the average return delivered by MFs in the same category. That is, only three out of 10 small-cap PMS funds delivered a 5-year return higher than 11.5% compound annual growth rate (CAGR), which is the average category return of small-cap MFs. Similarly, only 36% of large-cap PMS funds and 44% of multi/flexi-cap PMS funds outperformed the average return delivered by corresponding categories in the MF space over the said period.

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Does this mean investing in MFs has a higher probability of earning better returns? After all, MFs are highly regulated with a tax-efficient structure and low minimum investment limit compared to PMS funds.

The answer depends on the intent of individuals investing in PMS and their ability to pick the right portfolio manager, according to experts.

The data points to a huge divergence in returns between the best and the worst performers in the PMS space. For example, in the small-cap category, the PMS funds that were ranked the best and the worst based on the 5-year return (CAGR) delivered 16.7% and -5.6%, respectively, as of January.

Methodology

Note that the category average returns considered for the analysis are the simple average of the returns of all funds in the category. For assessing multi/flexi-cap PMS funds, flexi-cap MFs are considered because of its market-agnostic nature of picking stocks for the portfolio.

The PMS returns are the time-weighted rate of return (TWRR), which excludes the impact of intermittent cash flows from subscriptions and redemptions on returns for each strategy. MFs’ returns are based on point-to-point returns of the pooled fund over a period of time.

Further, “the classification of PMS funds across large, mid and small is based on the information shared by the PMS managers. There is no definition currently in the PMS industry that segregates funds based on market-cap allocation," said R. Pallavarajan, founder of PMS Bazaar.

“The data is based on 150 AMCs disclosing details with PMS Bazaar. These 150 AMCs represent almost 63% of the industry’s AUM," he added.

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Breakdown of performance

The lacklustre performance of the PMS industry in the long run of 5 years (see graphic) compared to MFs could be on the back ofconcentrated portfolios leading to higher volatility, according to industry veterans who do not want to be quoted.

PMSes generally hold a portfolio of 25-30 stocks, while MFs typically maintain a diversified portfolio of 40 or more stocks.

The increase in the number of managers in the small-cap and multi-cap PMS space in the last few years could have created a wider dispersion of performance, said Debashish Bose, founder and portfolio manager, OAKS AMC’s ABC Portfolio.

Talking about the underperformance by large-cap PMS funds, Munish Randev, founder and chief executive of CERVIN Family Office, said “I am not surprised. When most MF managers can’t beat the benchmark, the chances of PMS funds beating the benchmark are even less because it is not easy to beat the index by having only 15-25 stocks in a concentrated portfolio. Having said that, there are outliers in this space too, which have generated decent returns in the long run."

In the case of mid-cap PMS funds, almost 60% of them outperformed the MF category average.

Randev said, “mid-cap strategy works in a concentrated portfolio. MFs also beat the benchmark index, but their performance gets completely washed away because of over-diversification. The outperformance of PMS funds should be 90% and not just 60%. Most quality mid-cap oriented PMS managers beat the index more often than just 60%."

The same principle is not applicable for small-cap PMS funds, though, because of the higher risk that these stocks carry. “In the small-cap strategy, you do require a diversified strategy to average out the volatility. If it’s a concentrated bet, it is extremely high risk as the returns of the portfolio depend on just a few stocks and that makes the portfolio very volatile due to smaller traded volumes," added Randev.

Most PMS strategies in the industry are segregated under ‘multi-cap’ category because of limited restrictions on the selection of stocks.

While PMS multi-cap category is compared to the flexi-cap category under MFs, the portfolio of the former is tilted towards mid-cap stocks while the latter is focused on large-cap stocks, according to Randev.

Take note

HNIs consider investing in PMS funds because of the customized portfolios that it offers and also because of the opportunity it provides to invest in specialized investment themes or models that are readily not available in public.

“The way to look at PMS is how it compliments one’s overall portfolio. A differentiated portfolio which gives a different flavour, as compared to MFs, serves the investor well," said Rushabh Sheth, co-founder and co-CIO of Karma Capital.

Further, when selecting a PMS manager, return is an important parameter but not the only parameter.

“Investors must be aware that a PMS has a very high active share, has a concentrated portfolio, and the performance is based on the manager’s conviction. I think the most important thing to check is the long-term track record of the manager. And that track record must be measured across market cycles," said Jiten Doshi, co-founder and chief investment officer at Enam AMC.

Industry experts and wealth managers suggest that investors take the help of advisers to assess a manager’s style and how a strategy fits in the overall portfolio.

Santosh Joseph, founder and managing partner at Germinate Investor Services, said, “the weightage on the fund manager in generating returns is far higher in PMS space than in the MF industry, where most AMCs are institutionalized. It is important to understand the manager’s conviction, style of investing, and how his/her product fits the investor’s portfolio before investing."

Investors should take advice from an adviser who is not biased. “I want to highlight this because there are many advisers who are given huge brokerages, commissions. etc. So, one has to be a bit careful," said Randev.

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