SEBI with its latest circular seems to move the industry towards greater transparency, lower fee load on the end customer, and some amount of disintermediation. In today's post, we understand what portfolio management services are, what the current SEBI circular includes, and the key themes and direction that emerges for the industry.
What are Portfolio Management Services?
For the uninitiated, Portfolio Management Services are funds that are run for folks with relatively high ticket sizes (50lakh+). Given that these customers are generally more financially sophisticated than the average customer who invests in say a mutual fund, the regulations here are a bit more lax, providing greater flexibility to both the investor and the fund manager.
PMS vs Mutual funds: The broad differences here are around the minimum amount you need to enter (500 for mutual fund, 50 lakh for PMS), the frequency of disclosure necessary (daily in mutual funds, infrequent in PMS), and the amount of fees that can be charged (relatively more freedom in case of PMS). PMS can also be discretionary or non-discretionary, meaning you could either have the PM taking portfolio decisions, or providing advice and execution with the investor taking the final call. As discussed, due to the more sophisticated nature of people who invest in these products, the regulations here were historically less tight.
What are the recent changes that SEBI has incorporated for Portfolio Management Services?
1. Lower fee structure - Portfolio Management Services are prohibited from charging an upfront fee that used to be as high as 3% earlier. Exit load (the money you pay when you exit the fund and withdraw the money, put into place because the fund manager could have rebalancing & liquidity related challenges to work around) for exits in year 1(3%), year 2(2%), and year 3(1%) have a maximum cap, and no exit loads are allowed thereafter. Operating expenses barring brokerages are capped at 0.5% of AUM.
2. Greater transparency: Portfolio management services will now have to provide monthly reports to the regulator and quarterly reports to the client. This increases the cost of compliance to a certain extent.
3. Disintermediation - In its bid to remove costs due to excess intermediaries, portfolio managers have been asked to provide customers they reach out to directly to enter the fund via the direct route, with disclosure around the direct route to be shown prominently in marketing material as well.
What are the themes that SEBI seems focussed on?
For consistency, let's look at the implications of the changes across the same set of parameters.
1. Low cost - Wherever possible the regulator is trying to reduce the fees that can be charged to the clients. While this approach is certainly helpful in mutual funds and instruments focussed towards ordinary retail investors, investors in some of the other instruments are actually tremendously sophisticated and fully capable of understanding the net fees charged to them. They may, therefore, be willing to pay a higher fee for a highly specialized product that could be deemed infeasible at the regulated prices, leading to the destruction of value for all parties involved.
2. High Transparency - While the shift towards greater transparency is helpful to the investor, it increases the reporting and compliance burden on these funds, who now have to bear an incremental cost to service this need. However, we believe the current frequency isn't too rigourous, striking a good balance between cost and transparency.
3. Disintermediation - This is a secular theme throughout, as the regulators try to do away with intermediaries taking away vital chunks of return available. While intermediation might be necessary in the case of retail investors, for larger clients, the move towards disintermediation can certainly be seen as a positive one.
While some of the changes implemented will help the end customer, unnecessary overregulation, especially in areas where the counterparty is also a willing sophisticated investor, could be harmful to the sector as a whole. With the regulator stressing on these themes across investor segments, investors can see much lower fees and deal with a lot fewer middlemen going forward. It, however, becomes even more important to put in the effort to understand the investments you are getting into, and be cognizant of the flexibility that the instrument you enter in has, and how regulations impact that.
About the Author: The post is written by Ganesh Nagarsekar. Ganesh is a graduate from IIM Calcutta and has worked with J.P. Morgan and Goldman Sachs, before founding GSN Invest.
Disclaimer: This is an informational blog and is not meant to serve as investment advice.