PMS | Portfolio Yoga

Portfolio Management Services – understanding it better

At a time when Mutual Funds are seeing withdrawals, assets for Portfolio Management Service (PMS henceforth) are blooming. This even though Mutual Funds are better off when it comes to how one gets taxed as well as the fees. Mutual funds, even the active funds charge these days much lower than what the investor ends up paying at most portfolio management companies.

For the outsider – a Portfolio Management Service is very opaque. Maybe this is what gives them the edge – the exclusivity that investors demand after having achieved a certain level of financial well being. With the minimum investment of 50 Lakhs, its a signature investment of having arrived.

When SEBI introduced the concept of PMS, the spirit behind it was that high networth individuals would want to have professionally managed but personalized investment services. Before the arrival of rules, we did have brokers who acted as fund managers but without much oversight or transparency.

Today there is very little personalization in reality with most fund managers offering the same model portfolio for all clients regardless of his or her requirements or risk tolerance. The only difference lies in their ability to have a higher concentration versus Mutual Funds.

The biggest bane for the HNI investor is that mutual fund managers are never available to speak to unless one is big enough to move the needle for the firm. On the other hand, many Portfolio Managers will be happy to meet investors and if the investor is big enough, willing to drive down to his place if required. Whoever said Money can’t buy everything evidently hasn’t worked in the financial services industry.

Analyzing a mutual fund is very easy. It’s easy to get access to the funds historical day to day returns, their monthly portfolio’s, the fund managers letters and ability to compare the fund with others in the same category using freely available screeners.

Analyzing a Portfolio Management Service on the other hand is so much harder. Almost all PMS companies are wary of any disclosure of the portfolio – not even the top holdings get disclosed. Returns on the website of the firms are generally (with exceptions) dated.

Over a three year period, an investor could end up (markets being good and performance inline) paying the fund manager a few lakhs in fees. It hence makes sense to invest some money and time to decide on whom to bet with and there is nothing like a good old one to one personal dialogue with the fund manager to convince you of the merits of your decision.

Websites like PMS Bazaar offer a way to compare multiple PMS providers but only if they have tied up with the company. As per a Business Line article, they have tied up with just around 100 firms which means that 250+ firms are outside their database.

One can get the monthly returns from SEBI website where the same gets posted by the respective fund houses but until recently it was a single number regardless of the number of styles / strategies they were running. Also, did I mention the pain of trying to download data month on month for each fund house?

Returns of the past also need to be looked at with context of what is happening in the markets. In 2017, investors rushed to invest with small cap PMS funds only to get severely burnt as the markets rolled over.

Filtering down the list of suitable candidates with whom one wishes to invest is hard but essential for the next steps are time consuming. The key is to try and reduce the list of probable candidates to say 10 fund houses and then dig further.

So, how does one go about eliminating the funds one does not wish to invest into. For most investors, this process is by selecting only funds that are well known or have a large asset base or managed by a fund manager who they trust.

This eliminates the majority but also eliminates good fund managers for the single reason that they haven’t grown big for their brand to be noticed. In the Mutual Fund space this doesn’t happen because of availability of data.

Unlike Mutual Funds, we don’t have comprehensive data on how much of inflow is due to push sales and how much due to pull. While PMS is supposed to be for the discerning investor, there are still a lot of push based sales where the client takes the advice of the seller in deciding which fund he shall invest into.

In its early days, PMS was sold only by Wealth Management Firms for their clients. Today selling PMS is something that is undertaken by a whole gamut of individuals. Then again, while one shall get around 0.75% for selling a Mutual Fund, the fee a distributor gets for selling a PMS is much more liberal (some PMS share even the performance fee with the distributor who brought the client).

With minimum investing being 50 Lakhs (some PMS have a higher minimum), this for most would be a substantial investment. An investor faces two risks with any investment – the risk of an actual capital loss and the risk of an opportunity cost.

The risk of actual realized losses is easily spotted, tougher is to spot the opportunity cost. Benchmarking is one way to spot the opportunity cost. Beware though of using the wrong benchmarks for they can make an old person look young.

The best benchmark is not the Index but Mutual Funds. This is because other than for Large Caps, the other Indices suffer from a bias where their best stocks get removed frequently and thus limits their upside. The only stocks that are removed from Nifty 50 or Nifty 100 on the other hand are those that aren’t performing.

With very little if any disclosure of portfolio holdings, the next best step when it comes to analyzing a fund manager are his public writings – do note that not every fund manager writes a monthly or even a quarterly letter to clients and one that is provided to the public.

To understand a company, the key is to go through a few years of Annual Reports. Similarly, one would need to go through a few years of the letters. The idea is to get an understanding of the philosophy of the fund manager

The reason to read is that the investor would want to have a long association with the fund manager and that can only happen if the philosophy he talks about appeals to him. While returns are important, given the lumpiness of returns, the ability to stick with the fund manager during the bad times helps take advantage when the tide turns in favor of the strategy of the fund manager.

To better understand how lumpy returns can be, here is an example. A large PMS fund at the end of May 2020 had a 4 year CAGR of -1.60%. The CAGR at the end of May 2021 comes to 15%. 4 frustrating years were offset by one good year.

The only way to stay with the fund manager after seeing multiple years of gains being wiped out is only by having conviction both in the fund manager and the strategy he is implementing.

Not all PMS’s can be compared for their universe could be different. While the majority of PMS go for the Multicap universe, some PMS restrict themselves to Large Cap or Small Cap. This is an important distinction.

Size Factor is a phenomenon where it is observed that mid and small cap firms in the long haul have a tendency to outperform large cap. This outperformance comes from the portfolio’s being more risky in nature and the rewards if captured are a prize for taking those risks.

While Mutual Funds are forced by law to be more diversified – Concentrated Portfolios is the biggest differentiation for PMS. Concentration in itself doesn’t mean a higher risk though the volatility would be higher.

Finally, the elephant in the room is fees. Today, an investor can get an Index fund that costs as low as 0.20% of investment. Active funds but Directly invested by the investor would end up being charged 1% approximately.

PMS follow 3 different styles of charging to clients.

Fixed Fee Only: The fund manager here charges a fixed fee on the total assets managed and the calculation is similar to how it is calculated and charged at Mutual Funds. This ranges from anywhere between 1% to 2.5% of your assets.

The biggest advantage of a flat fee – it’s clean and easy know what one shall pay

Performance Fee Only: Rather than charging a fixed fee, some PMS firms offer to charge the investor a fee if they deliver above a certain hurdle rate. From the limited data I have, I have seen this hurdle rate being 6%. Given that until recently you could get 6% from a Risk Free Investment, this hurdle was in effect saying that if I don’t outperform the risk free, I don’t get paid. The way it’s calculated is that if a fund generates say 12% returns for the year, for an investment of 1 Crore and a performance fee of say 20% above 6%, you will pay 1.2 Lakhs (which is equivalent to a fixed fee of 1.2%).

The reasoning behind charging only a performance fee is to suggest that the fund manager will get paid only if he delivers for the client. While on the surface it seems logical, do note that in the long term, an Index fund has on an average delivered 12% returns.

Lower the hurdle rate, higher the fee the investor will end up paying. In good years like FY 2020 – 21 when Nifty went up 66%, the fee would come to 12 Lakhs( or 7.2% of the total current value of the fund – post 66% appreciation on an investment of 1 Crore). This of course assumes you invested on April 1, 2020.

While the investor will not pay any performance pay till the high water mark, if he were to exit during a drawdown, the investor would have ended up paying more than what he may have paid using the simple fixed fee route.

Fixed Fee plus Performance Fee: Finally, there are funds that charge you both a fixed fee and a performance fee. The hurdle rates here are a bit higher but not that high that makes it tough to generate any performance fee in the long run.

While this is how most Hedge Funds charge their clients, this is also in a way trying to maximize revenue for the fund manager at the expense of the client. In a good year like the one just gone by, the fee would easily be multi year fees for any active mutual fund.

Performance fee in my opinion should be calculated on the Alpha generated over and above the opportunity cost. The opportunity cost would be what one would have chosen as an alternative investment. But there is no such model available as far as my knowledge.

In addition to the fees, PMS also passes on all incidental expenses that are directly relatable to your account such as Broking, Demat, custody etc. This can easily come to 0.4% and something to keep note of.

For the investor, the biggest difference is how one gets taxed with respect to gains. If one is investing for the really long term, say Retirement Goal, with a Mutual Fund one pays Zero taxes as long as one remains invested. In a PMS, it’s normal for the investor in a PMS to regularly pay capital gains taxes on profits books by the fund manager.

Depending on the holding period of the fund manager, this can dampen the returns substantially if there is a high degree of churn. It goes unnoticed for most until the time to pay the tax arises. But in a good year, one is already happy and he or she is unlikely to complain with respect to paying taxes for the investment has grown substantially too.

The biggest advantage of PMS is the transparency (once you are a client) with respect to transactions. You get to know each and every transaction which while may not be really useful in the larger framework , it can provide you inputs on the thought process of the fund manager.

Once upon a time, Stock Brokerage was a personalized business which allowed the broker to charge you 2.5% and then some more and yet have the client not complain. Technology rudely awakened that Brokerage is finally no different from any other commodity business and the friction costs have reduced to Zero.

With the advent of more low cost ETFs that cover a gamut of strategies and tech enabled platforms, my view is that managing one’s one money based on one’s own convictions will become easier. While managing money may never become a commodity business, over time fees should go down from what is seen as acceptable today.

A new concept that is picking up in the US is “Custom Indexing”.An interesting concept where the advisor or his client has the ability to modify the portfolio to suit their custom requirements. Patrick O’Shaughnessy has a podcast which is worth a listen (Link).

FAQ on PMS by SEBI

Paying Advisor to Buy Blue Chip Shares

Twitter is a place where you meet Strangers. Some become friends for life, some acquaintances but most just some one whose tweet you once read and either agreed or disagreed. While Twitter is known for its Trolls and abusive behaviors thanks to the cover of Anonymity, there are people who are kind beyond what you feel you yourself deserve. For me, one such guy has been Muthukrishnan. I haven’t met him or even talked to him on the phone, barely retweet his tweets and have once in a while disagreed to. Yet, for some reason he showers more kindness than I receive from people I know better.

I don’t disagree on his overall philosophy though once in a way I do disagree. His view on buying stocks for dividend for instance. I have my reasons, he has his. A key question he is asking these days is – Should you pay a fund manager a % fee or worse a profit sharing fee to buy and hold Blue Chip Shares. He believes that fees eat into returns and hence one should not.

I agree with his view that fees eat into returns. But that is not the entire story and here is my view on why it may not be wrong to pay a good advisor to buy and hold great shares.

Vanguard US has a very nice graphic that shows that if you pay 2.0% per year over 25 years it would wipe out almost 40% of your final account value. If you have invested in a regular mutual fund, 2% is what you are charged. So, the number is not a huge assumption vs the reality.

The delicate question though is – Should you pay a manager to Buy and Hold Blue Chip shares. Now, this is not a strategy I know that is followed by most funds and here I mean PMS since Mutual Funds like it or not are measured against bluechip returns and hence forced to buy the very same bluechip stocks.

The flexibility SEBI allows PMS on the other hand is very huge when you compare versus a Mutual Fund Manage. From Large Cap to Micro Cap, he can invest anywhere. He can go to Cash for 100% of the portfolio value if he deems it necessary. Only thing he cannot do is take leverage – but an AIF fund manager can do even that.

Before we tackle PMS, let’s get the pesky Mutual Funds out of the way. Large Cap funds haven’t been able to beat the benchmark Indices for a long time now. With Reliance now being the biggest jockey, it can become even more pronounced as Mutual Funds are limited to holding not more than 10% of their Equity in one company while the weight of Reliance in the Index they track has moved well past that number.

Large Cap Mutual Funds are now called Closet Index Fund. From the web, a Closet Index Fund is defined as

A closet index fund is an actively managed mutual fund whose portfolio includes many of the securities in its benchmark index but whose expense ratio is higher than that of a true index fund or exchange traded fund (ETF) tracking the same index.

A simple ETF is available at 0.10% fee or lower. So, why the hell are people paying 2% (or even more in some cases). Are these guys really stupid? And we are not talking about a few folks either – Almost 81% of investors, that is 4 out of 5 investors come through the Regular route and hence are paying upwards of 2% as fees for having their funds managed by the Mutual Fund Companies.

With Indian Economy and Industry going nowhere, returns are pathetic and yet, the surge in assets we saw in 2014 is not going to topple over easily. So, why are investors staying despite pathetic returns that could have been achieved by safer methods and more importantly paying a 2% fee for the pleasure.

To understand that, we need to take a look at the bigger picture. While the Mutual Fund Industry has grown tremendously, it’s still small when you look at the “ Composition of Household Financial Assets”. As of June 2020, RBI estimates it at around 7%. This is the percentage of financial assets which ignores assets such as Real Estate and Gold.

That is 7% financial savings of Individuals are getting routed to the markets. This is fairly low but not surprising owing to not only lack of knowledge but also lack of safety net in India which means Individuals prefer safety of capital over its growth.

As someone who has been in the Industry for a long time, it’s not surprising that Industry veterans find it surprising that there are folks who are paying for non-performance so as to say. But what they are missing is the fact that most of the clients don’t have the financial knowledge required to handle their own monies.

The Internet has democratized learning but you don’t self-medicate (other than maybe Crocin or body pain tablets) just because you have read on the Net and understood what is ailing you. While not exactly comparable, for many they feel better off with someone – even if that someone is not really an expert himself but paints as one rather than take the risk himself.

The fear for most is losing money. It’s that fear that drives most to trust someone who they think will handle the money better than they can handle themselves. This fear is not about being paranoid either – whenever markets crash, even non business papers write in big bold fonts the thousands of Crores that has been lost by investors in a single day. This is a meaningless number, but who is to inform them of this.

The alternative path that most of these investors will choose without the ability to invest through an advisor is to invest in a Fixed Deposit. In fact, I am pretty sure that a lot of Investors who go to the Bank – a private sector bank to be more specific would have had the idea of investing in a Fixed deposit but were shown a different way to save and invested (hopefully since Banks are notorious for selling ULIP) in a Mutual Fund.

Markets have had a crappy time for a long time and regardless of what the Experts say, it’s unlikely to change in the coming quarters either. Yes, the darkest before dawn but the light at the end of the tunnel could also be the headlights of the incoming railway engine and not the end of the tunnel itself.

Either way, while investors seem to be getting a raw deal, the other options available to them aren’t any better either – invest in FD at a taxable rate of 5.5%?

Okay, I understand why small investors may be okay with high fees and pathetic performance, but what about HNI’s you may ask – Why are HNI’s willing to pay a fund (PMS generally) a fee for just buying and holding a set of high quality stocks.

While most PMS don’t buy and hold, I do know of a PMS that has a AUM of greater than 2000 Crores and buys and holds a portfolio of quality stocks. In the few years of data I could get access to, the client saw barely any change other than one stock being added after its Initial Public Offer.

The said fund charges no fixed fee but a performance fee over a hurdle that can be crossed even in these days by a liquid fund. Yet, the AUM keeps growing. What explains such incongruence. After all, here we are talking about sophisticated investors who can easily replicate what the fund is doing and save themselves a bundle. Why are they not doing it when it seems so easy?

In mid-2016, Saurabh Mukherjea came out with his book – “The Unusual Billionaires” where he showed how buying and holding a set of quality stocks over 10 years would have beaten most other funds not to mention the Indices. There was even a Interview where he listed out the stocks that currently matched the requirements (Link).

I used that list to create a portfolio (my own weighting method) and posted it on Twitter too.

https://twitter.com/Prashanth_Krish/status/799997097923645440

I bought and have been holding the same. A few months from now, it will be 4 years since I did that exercise. The portfolio itself is up 60% vs 42% by Nifty 100 which I took as the benchmark. No trades, No Fees, None whatsoever over the last 4 years – not tough, ain’t it?

The reason I have been able to hold is not only because I understand better but also because today it comprises just 10% of the equity portfolio. What if this was 50%, would I have been able to stay on?

Identifying Blue Chip stocks of today is easy – the problem is what will you do once they are no longer a blue-chip. An Index automatically chews over a stock that has lost its game and adds a new entrant, same goes for a fund manager who will chuck out a stock and buy what he believes is better instead. Stocks once considered blue chips and even many which were part of the Index today lie in ruin. Buying and Holding them would have meant not just an opportunity cost but also a real cost in terms of loss of capital.

By paying an advisor to buy and hold, many clients are basically outsourcing the pain component that involves selling the bad apples and buying new apples that appear suspicious today but in the end may actually deliver the goods.

Can this fee be lower? Of course, it could be – but like the Brokerage industry of the past, until a challenger emerges, why cut your own income. So runs the gravy train.

Personally I believe that funds that buy and hold good quality stocks and churn very little are doing a great service for while they may not get interviewed on Television every other day, the clients are assured of safety of capital.

Measuring returns based on what they could have achieved by buy and hold of the same is factitious since we can never be sure if they would have bought and held the same stocks or rather just used the money to buy a vacation apartment as an investment.

Should you invest in PMS Schemes

One of the great surprises of the 2008 financial crisis was that investing in Hedge Funds did not really hedge you when markets turned down. You lost as much if not more of what a simple Index fund investor would have.

While India has had a few Hedge Funds, one strong growth area has been Mutual Funds and Portfolio Management Schemes. This is not surprising given that most countries at one point or the other have seen a financialization of savings.

While both Mutual Funds and PMS are sold directly, a greater proportion has been sold by co-opting advisors by paying them a fee that is related to the amount of investment and the tenure of such investment.

This is not a new model and one that has been there for ages. In fact, in one post of mine here earlier I had highlighted how I started in business by canvassing for fixed deposits. The reason for such canvassing was the percentage cut I used to get. It’s amazing when I look in hindsight how for a small cut, we the advisor are willing to put our name at risk with friends and family.

Portfolio Management Schemes are seen as strategies for the sophisticated investor and the way we define sophisticated is that they are able to invest a minimum of 50 Lakhs to get an entry.

Why the high minimums? The idea is that if you have 50 Lakhs, you should be able to take a much higher risk (and hence afford to lose much more). No one wants to lose money, but without risk, there is no reward either.

I am sure most readers are familiar with what a PMS is, so I won’t expand on them but on why I don’t think PMS should be part of your investing basket. Yep, you read it right. My view is that other than the very rare instance, PMS doesn’t really add value to your investment

First, let’s see how PMS are different from a Mutual Fund. The biggest difference is that unlike in Mutual Funds where the funds are pooled and stocks bought for the whole pool with investors allocated units, in a PMS, all the stocks bought stay in your own Demat Account.

Does this really add value? Aashish Somiah explained in a tweet a while back on why this was advantageous to the investor.

PMS has chance to beat due to 1) concentration & no 10% cap 2) no pressure of fund flows 3) ability to charge as low as one wishes
— Aashish P Sommaiyaa (@AashishPS) August 15, 2016

Concentration is the key differentiator between a Mutual Fund and PMS for most part. Take for example HDFC Top 100 fund. It has 53 Stocks in the Portfolio. Most PMS on the other hand have portfolios of size that are 20 or lower. This along with good stock selection makes it possible to out-perform in bull markets though in bear market and sudden bear attacks like the one we saw in March, they are as caught as any other fund, personalized or not.

‘Will fund flows have an impact on your returns? It depends on multiple factors including the fund size. A small fund for instance may be forced to exit good stocks to pay off existing investors who want an exit leaving the rest holding illiquid and maybe bad stuff. This is especially true in Debt funds where funds saw their bad assets grow in size because of exits by other unit holders who were paid off by selling good assets.

But if the fund is of significant size, the impact from others behavior is lower though I don’t think there is an easy way to calculate it.

So, why don’t I think it’s worthwhile to invest in a PMS and instead a Mutual Fund or a Index Fund is a much better option.

The first reason is fees. Mutual Fund fees, especially direct are falling and now available at a much lower rate compared a few years back. Index funds for instance charge just around 0.10% (Large Cap) which is really rounding off error in the long term. You cannot go anycheaper than that for a market that is not the size of the United States.

PMS on the other hand have 2 types of fees. A fixed fee that is anywhere between 1% to 2% and a performance fee that incredibly is not linked to the market but a fixed return. This means that if the market moves up 50% and I generate 50%, I take a cut (above 5% or 10% or 0% hurdle rate). The only silver lining is that many firms do have a high water mark cut off which means that once you have paid a certain performance fee, the next fee calculation will start only above it.

Fees are a hindrance to Compounding. Longer the holding period, more the impact of fees. In 2018, Vikas Bardia wrote a post showcasing the difference in returns if Berkshire Hathway was a 2 and 20 Hedge Fund Manager. The clincher?

However, if instead of running Berkshire Hathaway as a company in which Buffett co-invests with you, had he set it up as a hedge fund and charged the usual hedge fund fee structure of 2/20 (i.e. 2% management fee + 20% of any gains), then the ₹10,000 investment would’ve only become ₹89 lakhs — the balance ₹10 crores would’ve been pocketed by Buffett as fees!
Vikas Bardia

The second impediment is tax. Till 2018, Long Term gains were tax free and till 2020, Dividend tax was paid by the companies. Both have changed and are negative to PMS investors versus Mutual Funds for PMS investing is treated to be the same as Individual Investing with taxes being paid every year.

Mutual Funds, Index Funds, PMS, AIF have all one thing in common – churn. Some are high, some are low and churn has costs that are common to all of them. Whereas the churn of your mutual fund will not mean anything for you, churn in the PMS needs action from your end in either having to pay the required taxes or claiming the losses for future set offs.

Launching a Mutual Fund requires 50+ Crores in Capital and 5 Crores (was 2 Crores until recently) in Capital for PMS. It’s not surprising to see the huge number of funds. I myself was until recently involved in a Portfolio Management company but unlike others we offered differentiation in terms of being able to have your own asset allocation mix and a price momentum portfolio that for now has no competition.

With more funds chasing the very same stocks, it’s not easy to really differentiate one from another. Finally, when investing for the long term, fees really add over time. As a saying goes, The only two certainties in life are death and taxes – we cannot avoid death, but we can to an extent save on Taxes.

SEBI sounds the death knell for boutique PMS.

In India, you can manage other people’s money in three ways – Mutual Funds, Alternative Investment Funds and Portfolio Management Service. While much of the world has only two options, Mutual Fund and Hedge Fund, PMS in India was a hybrid way for small fund managers to provide a way to manage the funds of each client in accordance with the needs of the client.

Of course, most PMS doesn’t really operate in that way. Rather every client regardless of his risk appetite is sold the same portfolio of stocks. In other words, PMS have become more like a Mutual Fund and one that suffers from tax disadvantage as well.

Few months back, SEBI constituted a Working Group to review the SEBI (Portfolio Managers) Regulations. The SEBI board yesterday met and approved the suggestions. Key changes are

Networth of the PMS firm is now raised to 5 Crores vs 2 Crores earlier
Clients now have to invest a minimum of 50 Lakhs vs 25 Lakhs earlier.
Custodian is now compulsory for all PMS. Earlier, you could have managed upto 500 Crores without the need for a Custodian
The fund manager now has to have a professional qualification in finance, law, accountancy or business management

In recent years, PMS’s have taken off with total assets under management crossing 140K Crores with more than 350 PMS in operation. The new changes, especially with regard to the minimum amount is bound to have an impact on the growth going forward.

The intention for all changes by SEBI is to safeguard the interest of investors. But the recommendations that are now applicable will reduce competition and actually hurt the interests of the clients.

In the United States, you can start your own mutual fund relatively easy. The cost of starting a mutual fund ranges from around 20 Lakhs to 80 Lakhs. In India, you need a networth of 50 Crores to start a Mutual Fund.

While the regulations for PMS aren’t as stringent compared to say stock brokers, we haven’t seen any PMS running away with clients money. On the other hand, you have multiple brokers who have vanished with crores of client money.

To avoid small investors from getting burnt in derivatives, SEBI has from the start taken a stand that the minimum size of the contract will be high. This was recently enhanced to an even higher level. But dig a bit deeper and you shall find that this has led to more clients losing more money than being saved.

Another rule that is now applicable and makes no sense is the requirement for a professional degree. Once again, there is no correlation to show that just because I have a professional degree in law, can I also be a great fund manager. But the higher powers seem to believe that.

A CFA certification in my opinion has a far greater value than a Management Degree since the focus is totally on understanding companies, their Balance Sheet and the ability to spot frauds and inconsistencies. Moreover, being international in reach, it ensures that the fund manager follows the best global practices.

The current move while not totally surprising is a retrogressive one. There are various ways in which SEBI could have safeguarded investor interests while at the same time provided for more choices. Sadly, once again we have missed that boat.

Links: Issuance of SEBI (Portfolio Managers) Regulations, 2019

Being Different Isn’t A Bad Thing

In the world of me too’s, the only way to stand out is to be different and it’s no different in the world of investment management where your only standing is why you are different from others and hence are attractive as a place to park your capital.

Motilal Oswal whose motto is, Buy Right – Sit Tight for example claims to invest its money following QGLP parameters – Quality – Growth – Longevity and Price.

Parag Parikh Mutual Fund on the other hand claims to be a firm believer in the concept of Value Investing and buy companies that are low on debt, high on cash and are good managements who can be banked upon.

Porinju Veliyath, a small PMS fund manager running a PMS fund from Kerala (Quick, Name the Capital of Kerala) too wanted and for a time has been different. While others swear by quality managements, Porinju believed in investing in companies that had good business but bad promoters / managements.

The concept in itself isn’t new for in developed countries, Hedge funds try to build stakes in companies handicapped by an indifferent management but one which otherwise has a great business. Once they acquire a significant stake, the next move is to try and get into management to enable them to change the behavior of the company.

From Bill Ackman to Carl Icahn to Daniel Loeb, activist fund managers for a time have been a huge hit in the United States as they went about breaking down the old companies in search for the elusive alpha.

Porinju model in my opinion was quite similar with the only difference being that in India, promoters own much larger stakes and it’s tough to take on an activist role. Yet, he was able to generate returns way above what could be gained by an do it yourself investor in the markets.

Here is the snapshot of his returns from the Disclosure Document

While Nifty is not the ideal benchmark given his penchant for investing in small cap and micro-cap stocks, the fact remains that, his fund returns are higher versus the correct benchmark – Nifty Small Cap 100 Index.

Unfortunately, great returns also meant that more investors got attracted to the fund. More the investors, tougher it’s to deploy and generate returns of the past.

One of the most quoted busts in history has been Long Term Capital Management. While there were many a wrong with the fund, what actually cooked the goose was the fact that they had reduced capital while continuing to hold positions which meant leverage ratio went up even further & one small spark and the whole empire came tumbling down.

The reason much of the active fund industry in America can hardly beat the Indices is that with huge money at their disposal, it’s tough to be different.

To be different means to take risks out of the ordinary – when it clicks, one is hailed as the next god of finance but when it fails, everyone is happy to take pot shots at how stupid (in hindsight) the strategy was.

Assume for a moment Soros went bankrupt in his campaign against the British Pound. Rather than being called the man who broke the Bank of England, he would have been consigned to history as a fool who tried to take on the Central Bank.

Micro Cap Investing comes with its risks and if the investor isn’t prepared for that kind of risks, he is invested in the wrong place.

DSP BlackRock Small Cap Fund (Erstwhile DSPBR Micro Cap) was the top performing fund a few months ago – but go back 10 years earlier and you will see that the fund was very nearly wiped out in the bust of 2008. While most investors would have dumped their holdings seeing such a loss, notional it maybe, they were again begging to be let in when the fund delivered humongously in this bull run to the extent that the fund house had to close new subscriptions.

Value funds under-perform in strong bull markets, Momentum funds under-perform in bear and sideways markets, Quality stocks of today can turn out to be Fraud stocks of tomorrow. But since they are all different from a plain vanilla market capitalization based Index fund, the probability is that they will turn out different results – hopefully for the better but could be worse too.

The reason for money getting attracted to Hedge Funds / Portfolio Management Schemes are for the reason that the fund manager has much more independence versus mutual fund managers who are mandated on what they can buy, how much they can buy, how much cash they can keep among others.

Difference is also the reason for funds to charge a higher fee than plain vanilla Index Funds or ETF’s which come at a fraction of those. If a fund behaves like a closeted Index fund, why pay 10x the fees?

Fund Management is no fun. It’s tough to manage one’s own emotions, let alone manage the emotions of hundreds of investors who have their own views. While wrongs need to be pointed out, mocking when one is down helps no one.

Disclaimer: I work as a Compliance Manager at a Portfolio Management Company. Views expressed here are my own. Consider me as biased in favour of Active Management.

Investing in Markets – Ways and Means

We have hundreds if not more number of studies that has shown that over the long term, the best growth is delivered only by equities. While in India, Real Estate has also proven to be a bonafide wealth generator, I strongly believe that growth over the next decade or two will more likely come in Equity with Real Estate more or less providing sub-optimal returns.

So, how does one go about in investing into the markets. For a lay man, there lies there options of investing his savings into the markets

1. Investing via a Mutual Fund

Theoretically speaking, this is the easiest way to gain exposure to the markets. But then again, not all Mutual Funds are the same and hence some amount of research is necessary to ensure that we invest in the funds that have showcased long term growth vs chasing funds that have made a mark in the very near past.

While most mutual funds in United States haven’t been able to beat the benchmark consistently, in India, we have hordes of fund managers who have beaten the benchmark returns year after year. Whether this is due to they being Genuis or whether its because of the fact that the benchmarks are not really that good a criteria to compare against is a story for another time.

But having said that, its a fact that top funds keep changing over time. Prashant Jain is a much acclaimed fund manager, but lets face the facts – his top fund, HDFC Top 200 has generated a CAGR return of 13.36% DSP BlackRock Micro Cap Fund which over the same period has seen a CAGR return of 24.5%.

What I have done above is known as Selection bias. I have selected the DSP fund not by foresight but by using current returns. In 2008 and 2009, the best large cap fund (5 year returns) was Reliance Growth Fund. Over the last 5 years, this fund has provided a CAGR return of 12.8%.

Over a similar period Nifty Total Return Index has shown a CAGR growth of 11.68%. While one can still argue about there being a alpha out there in funds such as HDFC Top 200 and Reliance Growth, we need to also consider the fact that they hold stocks outside of Nifty constituents and in essence, comparing the performance to Nifty is erroneous.

Personally my family is invested into multiple funds across the spectrum and overall, returns have been decent enough. As Warren Buffet once said, diversification is the only free lunch and this applies to Mutual funds as well.

A step above Mutual Funds comes a more personalized investment vehicle.

Portfolio Management Scheme (PMS for short):

Those who follow me on Twitter know that I am a very strong skeptic of PMS as a investment vehicle. My main objection comes from the fact that for most brokerage led PMS, this is not something where the objective is to generate above market returns for the client but is a nice way to churn the portfolio as much as possible in an attempt to garner as much brokerage as can be culled from the account.

In fact, it is a surprise that Assets under Management of PMS has growth substantially over the years despite most of them not even providing decent returns (let alone market beating) and worse of all, hiding the facts from the potential investors.

I do not have the break-down as which firm manages what amount, but just as a simple exercise, lets review the performances of top names in this business

Coming up first would be Sharekhan (Link)

AUM: Around 32 Crores

What surprises me is not the under-performance but the fact that NSE Nifty returns are shown as having given different returns when compared with different products.

India Infoline (Link)

AUM: 4600 Crores

India Infoline runs a multitude of funds

IIFL-1

Motilal Oswal (Link)

AUM: 1400 Crores

One of the few which has beaten their benchmarks. But then again, these are 1. Weighted Returns (and not everyone would get the same) and 2. Am not sure if these are after fees or before fees (Fees are substantial in nature, refer to page 14 of the document).

There are at least another 25 – 30 firms offering PMS, but I do hope you get the idea. PMS is not a ideal vehicle to ride the markets. In fact, one PMS firm actually managed to lose money when the markets were going up and lost money when the markets were coming down. The fund manager is now a star investment advisor 🙂

Last but not the least

Direct Investments into Equity:

Directly investing into equities is one of the most risky ways to put savings to work if you are neither willing to work hard nor have a clue about how markets work. Too many folks have burnt their hands in equity investing to swear off anything related to equity (Direct or not). But having said that, the only way to beat the returns generated elsewhere can be found here.

But if you are willing to put in the hours required to learn and understand the various way to analyze the markets, its a effort that can provide for worthwhile returns with total control in your hand.

But a caveat first – International evidence has shown that the average equity investor under-performs the markets very badly. In fact, many would have been better off just putting the cash under their pillow than investing into markets

While the above data comes from Mutual Fund investments and redemption by individual investors, with human psyche being the same, direct returns by investors would not be too different.

Investing (no matter how large or small your investments is) is a full time endeavor. Unless you are willing to devote a substantial amount of time, this is definitely not a area to dabble in since not only would the returns be below par, but the time spent could have been better utilized elsewhere.

To fill this gap, we have many a person offering to advise (Newsletter based generally) for a small fee. But with the vast majority of them being pure snake oil sellers, I would generally avoid all such stuff unless they have proof of their pudding (Audited returns of their own funds which in turn should be substantial portion of their net worth)

To conclude, while its true that some funds have shown ability to beat the markets, I recommend novice investors to distribute between a few select funds and a few ETF’s that track the index (Index funds). Invest regularly and you would turn out fine regardless of the gyrations we see in markets.

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