Mutual Funds

PMS doesn’t beat MFs in returns despite taking bigger risks

Parvatha Vardhini C BL Research Bureau | Updated on May 29, 2021

Performance versus comparable indices also throws up a mixed record

For HNIs (High Net worth Individuals), Portfolio Management Services (PMS) offer what mutual funds cannot. Yet, for the higher ticket size and risk that this product entails, PMS schemes lag mutual funds on average returns across popular categories, over both short and long timeframes.

PMS vs MF

Unlike mutual funds where one can start by investing a few hundreds or thousands of rupees, entering a PMS scheme entails a minimum investment of ₹50 lakh (since January 2020).

Today, mutual fund products are more or less straight-jacketed after SEBI’s new classification norms came out in 2018. This was done in the interest of retail investors whose investment ticket sizes are very small. PMS products have more flexibility. For one, if you invest ₹50 lakh across even 10 or 20 different mutual funds, the chances of overlaps in the stocks or other securities these funds hold will be quite high. Diversification, after a point, may not bring the intended benefit. For the same ₹50 lakh, a PMS holds just one set of high-conviction stocks/mutual funds or debt securities.

Mutual funds cannot take more than 10 per cent exposure to one stock. There is no such restriction for PMS. Some PMS schemes hold even 20-30 per cent in a single stock.

Due to liquidity constraints in smaller marketcap stocks, the investment universe for mutual funds may be quite narrow. Not so for PMS.

NAVs of mutual funds may get impacted if sudden mass exits happen from the funds. Since PMS holdings are in individual demat accounts, this problem will not surface.

 

However, for all the room that they have to manoeuvre, PMS funds don’t win hands down in comparison with mutual funds.

Data as on April 30 (latest available) from PMS Bazaar reveals that barring the mid-cap category, PMS schemes don’t take any clear lead over MFs across all timeframes (see table). In fact, in some time periods, PMS schemes also underperform comparable indices for the category. Moreover, like large-cap oriented mutual funds, large-cap PMS schemes also underperform the Nifty 50 index, making a case for passive investing.

Apples for apples

A comparison of PMS and MF until the recent past could draw criticism for the reason that there was no uniform way of calculating returns among PMS players. Until October 2020, AMCs could put out a single consolidated return for multiple strategies/funds. Some followed a practise of excluding returns of withdrawn portfolios or showcasing returns of only certain portfolios that are doing well. This apart, some reported returns on a ‘model portfolio’ basis where the composition of all client portfolios are maintained similar to the model. Reporting returns without considering the cash component in the portfolio was also prevalent (as some AMCs follow a system of not investing all the funds in one go and instead gradually deploy them in the markets). Sometimes, returns were also reported without netting off the fee and/or other expenses.

All this has been eliminated with SEBI mandating that PMS returns be calculated on a ‘time weighted rate of return’ (TWRR) basis from October 2020 onwards. TWRR takes into account in-between subscriptions and redemptions to the fund. AMCs must report TWRR returns separately for each strategy or investment approach (on a pooled basis), along with the benchmark returns for each. The cash component must be included for return calculation, and all expenses excluded. Thus, uniformity has come in now.

Takeaway for investors

The average returns of PMS funds are still to be taken with a pinch of salt, says R Pallava Rajan, Founder -Director of PMS Bazaar. This is because while the MF category average returns counts in all funds, the category average of PMS funds don’t present a full picture. Out of 361 Portfolio Managers, PMS Bazaar (aggregator) captures data of funds run by just over 100 of them. Yet, this may still be representative as the funds captured by PMS Bazaar constitute 60 per cent of the total industry AUMs as well as 70 per cent of investors in PMS schemes.

That said, there are always outliers to the average. The standardisation is a good opportunity for HNI investors to do their homework and choose consistent performers. Business Line Portfolio carries returns of top performing PMS funds based on 5-year returns (sourced from PMS Bazaar), in the second or third Sunday of every month. PMS Managers are required to submit a monthly report to SEBI where 1-month and 1-year returns for every strategy and the corresponding benchmark return is available publicly. Keep in mind though that PMS products may be opened and closed for inflows at a point in time, as per the decision of the fund manager.

Published on May 29, 2021

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