Addressing the faultline of misunderstanding between Mutual Funds and Portfolio Management investors 

Mutual Funds or MFs and Portfolio Management Service or PMS (considering only equity funds as of now) are among different routes to invest in equities (publicly listed stocks/ shares).

PMS is routinely offered to high net-worth investors (HNIs) as a superior investment alternative to MFs, by distributors and sales agents. They push investors to consider investing in the PMS (over MFs) because of their potential to generate ‘greater alpha’ as compared to the MFs (Alpha is the excess return of an investment, relative to the return of its benchmark). In effect, it is claimed that a PMS generates higher alpha than an MF.

Moreover, PMS is touted as a ‘personalised’ investment product since the holdings for each of the investors are held in a separate Demat account, whereas MF is a pooled investment vehicle. Also, the minimum investment for an MF is Rs.5000 that for a PMS is Rs.50 lakhs.

Given the above stated facts, MF gets branded as a ‘retail’ product whereas PMS is pushed across as a sophisticated investment to the HNIs. The objective of this piece is to verify both the stated claims with regards PMS as compared with the MFs i.e. their ability to generate higher alpha and being a more personalised investment product.

I analysed performance of 61 PMSes in the Multicap category and compared their returns with the average returns of set of 5 Flexicap MFs (Direct plans of the funds recommended by us to our clients in the past). The PMS returns for the 3 year and 5 year periods, for each of the 61 PMSes, was compared with the average returns (CAGR) of the 5 Flexicap funds, for the same time frame.

	Over 3 Years	Over 5 Years
Canara Robeco Flexi Cap Fund – Dir – Growth	23.04	19.83
DSP Flexi Cap Fund – Dir – Growth	23.62	17.48
Kotak Flexicap Fund – Dir – Growth	18.15	15.82
Parag Parikh Flexi Cap Fund – Dir – Growth	29.14	22.53
Average MF Return	23.49	18.92

Out of 61 PMSes, only 13 delivered returns higher than 18.92% over a 5 year period and also just 20 generated returns higher than 23.49% over a 3 year period.

Total number of PMS	61	61
Number of PMS beating average MF return	20	13
% of PMS beating average MF return	33%	21%
PMS beating average MF return	1/3rd	1/5th

In other words, only 21% (i.e. 1/5^th) of the PMSes generated ‘greater alpha’ over the recommended mutual funds (MFs), over a 5 year period.

With regards ‘personalisation’, while PMS fund managers face less stringent regulatory measures (vis-à-vis MFs) and have higher flexibility in being able to take ‘cash’ calls or to customise the portfolio for different investors or set of investors, but hardly any of them use it to their advantage, in their pursuit of colleting AuMs. Most of the PMSes follow the ‘model portfolio’ approach and the funds are invested in the initial days/ weeks, as per the pre-determined model portfolio. Though some PMSes, starting at the threshold of Rs.3-5 crores do offer personalisation across portfolios. Effectively, most PMSes work like ‘glorified’ MFs with little or no scope of personalization.

Conclusion – PMS or MF?

The short answer is: Both.

An HNI’s portfolio should comprise of ‘Core’ and ‘Tactical’ allocations. While Core portfolio is designed to meet long term investment objectives (7-10-15+ years), the Tactical portfolio helps take advantage of the prevalent market conditions in the short term (3+ years). PMS belongs to the Tactical allocation and hence investment in PMS should be governed by the ‘asset allocation strategy’ of an investor. Broadly, an allocation of 15-25% to Tactical investment opportunities is recommended.

A well selected PMS should complement the overall portfolio. In fact a good PMS should offer something which an MF cannot/ does not. For example certain PMSes are designed to pursue Thematic strategies, which an average MF just cannot emulate (so as to maintain a ‘mass appeal’) while others pursue Value investing which MFs are unable to practice due to their very construct. The decision to invest in PMS should solely be governed by such principles, while taking into account the investment philosophy, the team behind the fund and of course their long term track record.

To sum it up, PMS should be a part of one’s Tactical asset allocation to help bump up the overall portfolio returns but the selection needs to be such that it complements the overall investment portfolio and also that it falls in the top-tier of the funds on offer!