One of the most common doubts that comes to every investor’s minds is whether there is a difference between portfolio management services (PMS) and mutual funds (MF). Let’s tackle this issue in this article.
The market for PMS is at least theoretically much bigger than that for mutual funds. This may come as a surprise to many but that’s soon dawning on everyone. A large part of Demat holding in India is actually dormant and is not being managed in favour of investors. This coupled with the phenomenal growth seen in equity mutual funds in the past 30 years in India leads us to believe that the market is as much or may be even larger for equity PMS in India.
Mutual funds are a pooled vehicle. Generally, what happens with MF is that when the markets are booming then the performance is great. That’s when we tend to see inflows. However, it’s exactly the opposite when the markets are bad and the performance is bad. This is when we tend to see outflows. In a MF what happens because of the continuous inflows and outflows and the portfolios being managed as a pool, on the margins the portfolio either gets diluted or concentrated depending on whether there are inflows or outflows.
Major Difference between PMS and Mutual Fund
1. How are the funds managed?
In case of PMS, an individual client’s portfolio is held in that client’s segregated Demat account. Consequently, the sum total of actions of the other subscribers of PMS doesn’t impact any individual’s portfolio. For instance, if you were to subscribe for PMS today, at today’s buying prices, your shares will be credited in your Demat account. After that, as many customers come in or go out, it does not have any impact on the shares that are credited in your account at your buying price. This is one of the major differences between how a PMS behaves and how a mutual fund behaves. In a MF, on the margins, the portfolio keeps getting diluted on a daily basis. However, in PMS, for every client, a model portfolio is managed on a segregated basis.
As far as PMS is concerned, this works positively as well as negatively at times, there are no limits on individual stock holdings. As we all are aware, in a Mutual Fund, no stock can be more than 10% of the portfolio for a diversified fund. Thus, somewhere this means that in a MF, as a portfolio manager, on the margin, you are forced to sell your winners. Every time a stock crosses 10%, in somewhere around 9.5%, is when the MF will start trimming. It is absolutely mandatory to ensure that whatever the performance case may be, no stock can exceed 10% of the portfolio weightage in case of a MF. In PMS, at the service provider’s end, they could put hard caps around 15-20%, to exercise higher control. Thus, most PMS providers will start trimming once the stocks cross around 15-20% of the total portfolio. However, this is not mandatory like in case of mutual funds.
2. Fee Structure
In a MF there are only two classes – direct and regular. However, as far as PMS is concerned, there’s huge flexibility with fee structures and expense ratios. Depending on the size or slab of investment, there could be differentiated fees that could be charged. The other option that PMS leaves on the table is to charge performance-linked fee and keep the expense ratio much lower.
Mutual funds are held under a trust. In that sense, as per section 10(23D) of the Income Tax Act, MF is a tax-advantaged vehicle. When a MF buys and sells securities, it does not pay any tax because it is a trust. However, as far as PMS is concerned, it’s just like an individual buying and selling shares directly in the market. In PMS, every time a stock is sold in less than 1 year, if there is a gain, then that gain will be subject to short-term capital gains tax. Therefore, in PMS someone decides to have a trading strategy, then it would be at a distinct disadvantage compared with a MF. PMS is not a tax-advantaged vehicle, which provides MF with an advantage since they are one.
These are some of the key differences as far as PMS and MF are concerned. However, always keep in mind that the retail holding by way of equity shares in people’s Demat accounts, that part of the market is almost 4 times that of the equity mutual funds business. Equity mutual funds are ideal for those who have investing in fixed income, conservative investors, retail investors, or those who want to invest in SIP. However, Portfolio management services is an ideal option for those who are used to holding equity shares in their Demat account.
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