Are clients incurring additional taxes to pay management fees in a PMS?

Select fund managers that spoke to Moneycontrol on the condition of anonymity said that investors are typically given two options: they can either pay the management fees out of pocket or permit the fund manager to sell a stock to cover the fees.

In a Portfolio Management Service (PMS), fund managers often sell a portion of the stocks in the portfolio to collect their management fees and this practice results in the client incurring additional taxes, as every churn in the portfolio is taxed, said people in the know.

Market experts say this practice impacts the clients who have been in the fund for a longer period more, as their fully invested portfolios may require the fund manager to sell a stock to cover fees.

Select fund managers that spoke to Moneycontrol on the condition of anonymity said that investors are typically given two options: they can either pay the management fees out of pocket or permit the fund manager to sell a stock to cover the fees.

A PMS can collect the management fees either monthly, quarterly, or annually. Along with management fees, the fund manager also takes other charges like depository charges, custodian charges, among others.

To be sure, a fund manager said that the tax impact from selling a stock to cover management fees is typically minimal as only a small portion of the stock is sold to match the fee amount, resulting in a relatively low tax liability.

While select fund managers sell the stock to collect the management fees, some avoid it by taking a different route as well. Prasanna Bidkar, fund manager at Paterson Securities explained that their PMS ensures at least 1 percent of the portfolio is held in liquid ETFs, allowing them to deduct management fees from this reserve. Additionally, dividends from stocks are used to cover the fees.

He also generates cash while portfolio re-balancing. For example, if after a year the 1 percent cash reserve depreciates and dividends are insufficient, the PMS will adjust during portfolio rebalancing. While selling a stock (e.g., Stock X) with a 5 percent weightage, they might buy another stock (e.g., Stock Y) with a 4.5 percent weightage. The remaining 0.5 percent is then utilised to cover the management fees.

Incidentally, the practice in the PMS industry is in sharp contrast to that of mutual funds that operate under stricter regulations thereby offering more transparency and industry-wide uniformity in the manner of collecting all expenses related to fund management.

For equity mutual funds, each AMC takes its own call on the cash holding position, said Abhishek Kumar, of Sahaj Money. He added that in the case of debt mutual fund SEBI has mandated that "all open-ended debt schemes (except Overnight Fund, Liquid Fund, Gilt Fund and Gilt Fund with 10 year constant duration) shall hold at least 10 percent of their net assets in liquid assets".

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