PMS vs Mutual Funds: Which Structure Makes Sense for High-Value Investors?

PMS vs mutual funds differ primarily in investment structure and ownership. For investors with a minimum investment of approximately ₹50 lakh, the selection criterion shifts beyond diversification to structure. Should the investor choose a PMS for direct ownership of portfolios, or a mutual fund for ownership of units of a pooled investment with access to professional management?

PMS and mutual funds each have their strengths. PMS can include the ownership of a more customized portfolio, while mutual funds provide diversification at the cost of ownership and control. The decision revolves around the investor’s preference, the investment’s risk and return profile, the required level of investor participation, the liquidity requirements of the investment, the prevailing tax environment and, of course, preferences around control and customization.

This article is centered on a comparison of PMS vs mutual funds in the context of high net worth Indian investments and without the assumption that a higher investment automatically means a preference for a PMS.

PMS vs Mutual Funds: The Key Distinction

The principal difference is the structure of the investment and the ownership thereof.

In a mutual fund, many investors combine their investments in a pool. The mutual fund then creates units after computing the applicable Net Asset Value (NAV). The fund manager guides the investment of the pool as per the scheme’s investment objective and the regulatory framework. The investor, in this instance, only owns the mutual fund unit and will not own the individual investments of the scheme.

PMS provides a personalized portfolio for each of your clients. For securities that are listed, the investor typically has the securities held in the investor's own Demat account, and the PMS Manager would take the investment decision in line with the mandate. SEBI's PMS investor material differentiates between discretionary and non-discretionary PMS arrangements and states that the minimum investment amount for PMS is ₹50 lakh, subject to the applicable regulatory framework.

Portfolio Ownership: An Important Feature of PMS

Investors with high net worth view the ability to maintain direct ownership of their portfolio as a key feature of PMS.

When securities are listed and a PMS arrangement is in place, the portfolio is maintained at an individual level. This eases the understanding of exposure at the security level at the individual investor level, as the individual investor is not owning a fractional part of a pooled mutual fund scheme. Instead, the investor receives a portfolio of securities that is subject to the PMS strategic framework.

This will be of particular relevance to an individual investor where there are already held shares, avoidance of particular companies or sectors, or for that individual's portfolio, other considerations have to be accorded to the holdings.

For instance, an individual with a large family business exposure may not want to have an additional family business exposure through another strategy that adds a significant exposure to that company. Here, a PMS mandate may be more flexible than a mutual fund scheme, as long as it is within the retail portfolio manager’s strategy.

Customization: PMS Leads the Way

Customization is one of the primary factors for an affluent investor to opt for PMS.

A mutual fund manager has to manage investments as per the scheme’s objective and the applicable portfolio norms. Each investor of that scheme is exposed to the same underlying portfolio (except for unit and transaction differences and the applicable plan)

PMS models can be customized to align with a specific style of investment and client preferences. Some services enable portfolio managers to consider an investor’s existing holdings, allocation preferences, risk tolerance and/or specific investment constraints.

It is important to note that customization does not equate to complete flexibility. A PMS strategy is constrained by the jurisdictions in which it operates, regulatory frameworks, and the overall investment process. A high degree of customization does not necessarily equate to a significantly more personalized investment strategy, and thus does not necessarily equate to a lower risk investment strategy.

Diversification: Mutual Funds Have a Built in Structural Advantage

For a straightforward diversification goal, mutual funds tend to be appealing.

A mutual fund offers exposure to a portfolio of securities selected by a fund manager. The portfolio may include equities, bonds, money market instruments, or other permissible investments. By investing in a mutual fund, an investor gets diversified exposure, all without the need to conduct research and monitoring for each of the securities.

Like mutual funds, a PMS (Portfolio Management Service) can also be diversified, but the level of diversification here will depend on the specific strategy. A PMS focused on a company may deliberately hold a focused portfolio of fewer stocks, while another strategy may diversify exposure across a wider number of companies or sectors. The goal here is to hold a diversified portfolio, which can only be achieved by strategically selecting stocks, which in turn means diversification.

By no means does a PMS focused on a company become more diversified because the investor is bringing more money to the table. The construction of the portfolio will be more important than simply the label.

InvestEdge360's mutual fund resources can help you learn more about the pooled investment structures.

Understanding Fees: Transparency is Key

Fee transparency should be a focus area when comparing PMS and mutual funds. Each PMS agreement may outline three broad components: management fees, performance fees, or a mix of the two. Regarding PMS investors, SEBI states that the fees for portfolio management will depend on the agreement with the client.

Mutual funds have expenses at the scheme level that are regulated. The fund structure and NAV incorporate scheme expenses, so the investor will not receive a separate bill for each portfolio management activity.

For an informed investor, the comparison of fee percentages is not as easy as it appears. Consider the economic cost of the entire structure - advisory fees, performance fees charged, brokerage commissions, taxes, exit fees, cost of portfolio turnover.

A PMS may have a higher stated fee than a mutual fund, but a personalized service should never attract an unfairly high fee.

Taxation: PMS and Mutual Funds Are Not the Same.

Taxation is yet another element that differentiates these structures. It has to be analyzed carefully since the tax outcome will depend on the type of security, holding period, transaction, investor status and tax rules applicable in the financial year.

Generally, in a PMS, the client owns the underlying securities held in the client’s account. Transactions done by the portfolio manager may result in capital gains or losses at the investor level based on the applicable tax treatment.

In a mutual fund, the investor becomes taxable when he/she transfers or redeems units of the mutual fund, and the tax treatment will depend on the type of mutual fund and the provisions applicable.

Current tax provisions have certain differentiations for equity vs. debt funds. AMFI has published some tax related information for investors, and this should be checked (it may be necessary to update this information) before publishing or tax planning is done.

The Income Tax Department in India has adopted a viewpoint that any profits or gains that accrue from the sale of a capital asset will be dealt with under the provisions of the tax framework for capital gains, and the details of the tax computation will need to be determined on this basis and the facts of the case.

So a large investor should not select PMS based on the presumption that direct ownership will be more tax efficient. A tax professional should evaluate this for the client.

Risk: Customization Does Not Mean Lower Risk

Both PMS and mutual funds have market risks. The extent and type of risk will depend on the nature and the way the underlying portfolio is managed.

A mutual fund, based on its mandate, can diversify by investing across companies, sectors and/or asset classes. A PMS strategy can diversify as well, while some may intentionally concentrate on a smaller number of securities.

Concentration increases the impact of a particular stock or sector on a portfolio’s performance. However, too much diversification may dilute the strategy and make it unable to carry out its strong convictions.

What the correct question should be is not whether PMS is riskier or safer, but rather:

• What is the holding number of the strategy?

• How concentrated can the portfolio be?

• What segments of the market and which sectors can it invest in?

• What is the strategy’s position regarding drawdowns?

• What level of volatility does the investor permit?

• What is the strategy’s policy regarding cash and liquidity?

Can a High-Value Investor Really See Something Through PMS?

PMSs have a high level of transparency since each investor’s portfolio is made of individually held securities. Because of this, it is easy to identify securities, quantities, and transactions at the portfolio level.

Mutual funds also offer a high level of transparency to investors by disclosing the objective of the scheme, portfolio updates, NAV, and other mandated disclosures. However, the investor holds units of the scheme, as opposed to the underlying securities.

Thus, visibility should be evaluated within the framework provided. Having visibility of individual stocks in a PMS account does not imply the strategy is better. Likewise, holding units of a mutual fund does not suggest the investor lacks visibility of the underlying portfolio.

The disclosures in the structures designed by SEBI and AMFI's investor education resources provide a good preliminary understanding of the disclosures in these structures.

Liquidity: Mutual Funds Might Be Easier, but the Type of Scheme Matters

Liquidity is normally confusing when PMSs and mutual funds are compared.

Most open-ended mutual funds permit redemption of units on business days subject to the scheme’s rules, cut-off, and exit load, if any. However, not all mutual fund structures offer the same liquidity. Some mutual funds may have a different redemption scheme.

In PMS, the liquidity of the portfolio depends on the underlying securities, strategy, and terms of the PMS. Selling individual securities, particularly less liquid securities, may have a big impact on the market.

For investors needing to access a large cash outflow on short notice, the concern isn't PMS versus mutual funds. Rather, it is how quickly can a portfolio be converted to cash while calling for the least damaging market execution and outcome.

Minimum Investment: Why ₹ 50 Lakh Changes the Conversation

As per SEBI's PMS (Portfolio Management Services) norms, clients must invest a minimum of ₹ 50 Lakh, and the number of funds / securities must satisfy applicable rules. Because of this high minimum investment, the discussion around PMS usually revolves around the high net worth and ultra high net worth investors.

Just because an investor has ₹ 50 Lakh, doesn’t mean he must invest that amount into PMS. The reason an investor must have ₹ 50 Lakh is to determine whether he satisfies the minimum investment requirement, and has no bearing on the appropriateness or suitability of the investment.

Products can satisfy investors’ requirement even beyond ₹50 Lakh. For instance, a ₹75 Lakh investor can prefer mutual funds because maybe he values simplicity and diversification more than the benefits of PMS.

Products can satisfy investors’ requirement even beyond ₹50 Lakh. For instance, a ₹75 Lakh investor can prefer mutual funds because maybe he values simplicity and diversification more than the benefits of PMS.

Who May Prefer Mutual Funds?

Mutual funds can be more suitable for investors who require simplicity and standardization and a high degree of diversification in their investments.

• Investors may prefer a single scheme to get diversified exposure.

• Investors may not need customization at the stock level.

• Investors may require a standardized process.

• Investors may prefer using SIPs (Systematic Investment Plans) or other systematic investment tools, if and when available.

• Investors may access different asset classes and fund categories through established products.

• Investors may prefer to evaluate schemes using standardized disclosures, portfolio information and performance history.

For investors having Rs.50 Lakh, Rs.1 crore and even more, mutual funds may be perfectly adequate. Having more wealth does not necessarily make pooled investments inappropriate.

Who is PMS for?

Considering PMS makes sense for investors with specific needs for customization on a portfolio level, and the understanding that it comes with additional complexity.

• The investor wants to own the underlying security.

• The investor wants a portfolio built to fit a certain strategy

• The investor has other securities that have to be part of the portfolio.

• The investor understands that concentration risk and risk related to strategy increases.

• The investor hires a professional portfolio manager to run the investments according to the agreed upon mandate.

• The investor meets the qualification for the PMS mandate and understands the fee structure.

SEBI's PMS investor charter separates discretionary, non-discretionary and advisory services. Because of this, investors must understand which of the three services they have been offered.

PMS vs Mutual Funds: A Practical Decision Framework

Questions to consider prior to selecting a PMS

1. What is the investment philosophy that underpins the PMS? Do they focus on value, growth, quality, factor-based, thematic, concentration or diversification?

2. What is the maximum concentration? What is the maximum allocation that the strategy is able to invest in an individual stock or sector?

3. What are the total costs? What are the fixed fees, performance fees, and other related costs?

4. How is performance communicated? How is performance reported along with the benchmark and portfolio level information?

5. What occurs during severe drawdown? Understand the investment philosophy. Know the strategy beyond performance, and how the manager manages portfolio risk.

6. What is the process to withdraw? Know how a request for withdrawal is communicated, and understand the estimated time for complete liquidation.

7. Is the firm properly registered? Does the firm have the necessary regulatory status? Are the necessary disclosures available?

Investors also have the opportunity to examine the dedicated Portfolio Management Services resources prior to considering a PMS arrangement.

Should an Investor use PMS and Mutual Funds?

There is no hard rule preventing one from using both. Different structures serve varied purposes in a given high-value portfolio.

An investor using diversified mutual funds for a core allocation may consider PMS for a focused allocation that provides the opportunity for high customization, for example. Conversely, other investors may prefer to only use mutual funds, as the focus remains on simplicity and diversification throughout the portfolio.

You avoid having products just because your portfolio is now bigger. You invest products that have clear goals, and you evaluate your concentrated and diversified portfolio to check for redundancies, liquidity and risk.

How to Analyze PMS vs. Mutual Funds Before You Invest

Evaluating historical performances is not the only measure used for comparison. Before selecting either, examine the PMS and the mutual fund schemes on the following criteria:

• Investment objective and strategy

• Portfolio concentration

• Assets and sector exposure

• Investment process

• Minimum investment

• Total fees and expenses

• Portfolio turnover

• Liquidity and withdrawal process

• Tax implications

• Benchmark and performance reporting

• Risk management

• Regulatory and disclosure framework

Approaching the comparison this way helps avoid the common mistake of selecting a product with better recent returns. Past performance can change. Higher returns over the last few months from a particular scheme should not be the only reason to select it over other schemes with higher risk levels.

PMS vs Mutual Funds: The Verdict

Finances wise, there is no winning answer between PMS vs mutual funds. Investors may prefer PMS over mutual funds when customization, direct ownership and investment around a particular mandate are important. For simplicity in a portfolio, mutual funds over PMS will be the preference.

For an investor, the first step should be to decide the role the particular investment will play in the overall portfolio. The ₹50 lakh PMS threshold is a consideration for investing, not an endorsement. Also, mutual funds should not be confused for an inferior investment strategy.

Compare all the strategies, costs, risks, liquidity and reporting on the investment before actually investing. Finally, select the investment based on the structures that best suit your overall portfolio goals and objectives, even if the investment you are considering is only a small part of your overall portfolio.

Investor Disclaimer

This article is for educational and informational purposes only and should not be replaced with real investment, tax, legal or financial advice. There is a risk associated with the market, and the return is not guaranteed for PMS and mutual funds. The investors are required to make their own assessment and decision based on their goals, risk appetite, and financial status. There are chances that the fees, regulations, taxation for PMS and minimum requirements, and the tax treatment of mutual funds may change. The investors are advised to reach out to the SEBI, the portfolio manager in charge, AMFI, mutal funds, and tax professionals to get the latest information and act accordingly.