A look at the one-year returns across roughly 250 equity Portfolio Management Service (PMS) strategies published by PMS Bazaar on their website, shows returns ranging from minus 28 percent to positive 46 percent. Unlike investing in equity diversified mutual fund schemes, where categorisation is standardised, portfolios are benchmarked and hugely diversified with at least 40 stocks or more — investing in PMS portfolios is a different ball game.
Although PMS portfolio returns are comparable to a stated benchmark, the portfolio itself may have nothing in common with it, given the high level of concentration and unique stock selection. These portfolios are concentrated with 20-30 stocks and rely heavily on the unique fund management style of the portfolio manager. These features contribute to outlying performance, both on the upside and the downside.
Data also shows extreme volatility in returns and performance across time periods. For example, Renaissance Opportunities Portfolio, which is the top-performing large-cap strategy on one-year return (data from PMS Bazaar), does not feature in the top three when you look at three-year returns. On the other hand, Reliance Alpha, another large-cap strategy, which was at the bottom in three-year return, is among the top five on relative performance when you consider the last one-year return. Seeing this performance flip flop, you may be tempted to exit one portfolio and pick the next rather frequently; a temptation that should be avoided.
PMS exits can be painful
Unlike mutual fund scheme exits, exiting your PMS scheme may not be as simple as submitting a redemption request. First, you have got to take care of the taxation on your PMS portfolio. Every buy-sell transaction is taxable. Hence, deciding to exit based on a performance assessment done too early in your holding period can result in a significant tax out go. Remember, in a PMS scheme, you hold individual stocks in your demataccount. If you exit your PMS scheme, your fund manager terminates his lien (control or power of attorney) over your portfolio, and puts the control of the stocks in your hands. You are then free to sell them. Get ready to pay tax; 15 percent short-term capital gains tax if you sell them before a year; 10 percent long-term capital gains tax if you sell stocks after a year. To be sure, equity MFs also carry the same tax rules when you sell them, but unlike in an equity scheme where you pay tax once, in a PMS you pay tax on as many shares as your fund manager has held, and which you want to sell.
Secondly, PMS portfolios have high conviction, concentrated positions in single stocks. Such strategies not only take time to deliver expected returns, but also buying stocks may be spread across a few days or weeks for individual client portfolios. In a market environment that favours a certain theme or sectoralbent, unique PMS portfolios which don’t hold stocks from these sectors may take longer than expected to deliver returns. Your exit might be a bit premature if your fund manager is in the middle of executing his game plan.
Thirdly, you may be looking at the top-performing PMS and comparing your own PMS returns with that. However, if the strategy and market capitalisation category are not the same for the two portfolios, it’s really comparing apples with oranges.
Lastly, it is time consuming. Exiting one strategy means closing the demat and broking account linked to that PMS. Operationally at the time of exit, you can transfer the securities or the cash to your account or you can transfer the securities to a new fund manager. A typical exit process can take anywhere between two to three weeks.
What about underperformance?
If you find that your PMS portfolio is indeed underperforming compared to other strategies within the same market category (large-, mid-, small-, multi-cap strategies), instead of looking only at the returns for a period, go through your portfolio a bit minutely and closely. With limited number of stocks, say 15-25, in one portfolio, returns can look very different across fund managers.
You will have to get down to individual stock quality, financial health of the company and future earnings potential. Tap into your PMS fund manager to understand these nuances.
According to Vishal Dhawan, Chief Executive Officer and Chief Financial Planner, Plan Ahead Wealth Advisors Pvt Ltd, “One benefit of investing in PMS is getting direct access to the fund manager. A lot of this is about philosophy and it’s important to speak to the portfolio manager to understand the investment philosophy better. The ability to have a deeper conversation is also aided by the limited number of stocks in the portfolio.”
Short-term underperformance may not truly reflect the long-term quality of the portfolio. PMS portfolios are not designed keeping a benchmark index in sight. Fund manager strategies are highly individualistic. Hence, comparing performance against a benchmark or peers can be confusing. Look instead for consistency in performance within the relevant category and against the stated benchmark.
Ideally, PMS investing is for high net-worth individuals who have seen market up and down cycles. These portfolios are known to deliver premium returns but with extreme volatility. The key (like for other equity portfolios) is to remain invested for a few years, at least to see how the portfolio can truly deliver equity returns. Dhawan suggests a minimum three-year investment before taking a call on whether to stick or exit.
“We prefer to invest in those PMS strategies where the founder is also the chief investment officer as there is greater accountability and skin in the game. There is also constant communication even when the performance is lower than expected, one can dig into details of each company and the portfolio as a whole,” says Jinay Salva, Founder, Indigenous Investors.
The PMS approach
Investing in PMS strategies goes beyond just getting equity exposure in your portfolio. Rather, it is more about creating excess return by diversifying your equity exposure to add specific strategies and investment styles, which you may not already have in your equity portfolio. This means a lot more research is needed at the time of investing, rather than risking being invested in a poor-quality portfolio. This involves several layers, including some of the steps below:
- Understanding your fund manager’s style and strategy thoroughly. For example, are they momentum chasers versus value investors, and so on. Look at the detailed stock selection and performance track record across market cycles.
- Understanding what the fund manager intends to do when stock selection goes wrong. How long to they hold on to a bad stock call?
- Availability of the fund manager to discuss his outlook and portfolio at periodic intervals is also important.
- Understanding the basis of the hurdle rate (defined return for a profit share arrangement with the manager) and also data on the frequency with which this may or may not have been missed in the past.
Salva says many clients prefer a profit share to begin with, as it ties the in performance of the scheme with remuneration for the fund manager.
What should you do?
Give your PMS portfolio time to mature and the stocks in it the appropriate length of time to deliver returns. If you are still dissatisfied after a minimum three years of experience with the portfolio, you can consider switching to a different strategy within the same PMS manager or switching to a new PMS manager. The exit can be in cash or in stocks as well, if you choose to continue holding the portfolio. What is more important than contemplating an exit is spending good enough time doing your research before buying into a specific PMS strategy.
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