SEBI proposes landmark changes to PMS regulations, some loopholes remain

Mumbai: A SEBI working group has proposed a host of changes to make Portfolio Management Services (PMS) in India, more transparent and investor friendly.

Key changes include increasing the minimum investment in PMS from ₹25 lakh to ₹50 lakh, standardizing reporting requirement and moving distributors from upfront to trail model. However there are a few misses, no caps have been proposed on PMS fees, akin to TER (Total Expense Ratio) in Mutual Fund. The recommendations also do not mandate explicit public disclosure of holdings and returns which makes comparison and transparent selection of PMS products difficult. The working group report has been opened by SEBI to public comments.

PMS in India are governed by the SEBI (Portfolio Managers) Regulations, 1993. PMS emerged as an alternative to mutual funds to high net-worth investors who were willing to take some extra risk for higher returns without being subject to the various investment restrictions on mutual funds imposed by the market regulator.

However, PMS services have suffered from lack of a standardized and easy-to-understanding reporting format and lack of transparency with regard to fees and charges. The carnage in mid and small caps has also hit PMS products focusing on them, with one PMS manager reportedly offering to transfer stocks to client demat accounts rather than money obtaining by redeeming the stocks in question.

Their relatively high commissions caused distributors to push them heavily as SEBI steadily brought down fees and costs in mutual funds. “PMS really took off after entry loads in mutual funds were abolished by SEBI in 2009," said Gaurav Awasthi senior partner, IIFL Wealth Management Ltd, a financial advisory firm. Further caps on upfront distributor commissions to 1% in April 2015 gave a fillip to PMS.

“The sharp increase in assets under management (AUM) of PMS after the strict cap on mutual fund commissions in April 2015 was an expression of fee disparity. Most advisors increased their allocation to PMS from 0-10% to 30-40% in the last three-four years," said Feroze Azeez, deputy chief executive officer, Anand Rathi Wealth Advisors Ltd. The ban on upfront commissions in mutual funds as per a SEBI decision in 2018, placed PMS services at a further advantage to mutual funds.

The SEBI Working group has proposed that distributors in PMS should also be paid through an all-trail model. Only those individuals who have passed the NISM Mutual Fund exams or who have an ARN number for mutual funds should be allowed to distribute a PMS until separate norms are formulated for certification of PMS distributors. The Working group further recommended a code of conduct for PMS distributors.

It recommended an increase in the minimum net worth requirement for a PMS manager from ₹2 crore to ₹5 crore. However the amount proposed is still dramatically lower than mutual funds. An Asset Management Company (AMC) running a mutual fund is required to have a minimum net worth of ₹50 crore.

The working group noted that different PMS managers are adopting different ways to report their performance. It recommended that the time-weighted-return method be adopted across managers in order to exclude the effect of extraneous events like deposits and withdrawals. It further recommended that frequency of reporting to clients be increased from every six months to every three months. In contrast, mutual fund NAV (Net Asset Values) are declared on all business days. Furthermore changes in investment approach or Principal Officer of the PMS should also be reported to clients. Marketing materials and website should match what is reported to SEBI, the working group added. “However public disclosure of performance and holdings is missing, which makes it difficult to evaluate different PMS products," said Awasthi.

With regard to fees, the working group recommended that in case of performance fees, they should be levied without ‘catch up basis.’ Catch up basis is a methodology used to compute performance fees in relation to a ‘high water mark’ a previously reached value which needs to be subsequently exceeded in order to charge performance fees. The working group also proposed a cap of 0.5% on ancillary expenses other than brokerage but failed to recommend a Total Expense Ratio (TER) cap similar to mutual funds. “Considering how easy it is to set up PMS services compared to AMCs, lack of a TER cap is a major lacuna," said Azeez.

With regard to investment products, the working group proposed that the PMS manager should only be allowed to invest in listed securities (presently unlisted securities are also permitted). In case the PMS invests in mutual funds, the working group proposed that it should only be allowed to invest in direct plans of mutual funds. A number of wealth managers offer PMS services investing in regular plans and these may have to be restructured.