PMS vs Mutual Funds

Why rushing into a PMS isn't a great idea…

Many banks and financial institutions shifted their focus from mutual funds to PMS a few years back. The reason? Mutual Funds became cheaper (read - better) for investors and less lucrative for advisors in terms of fees and commissions. PMS products, on the other hand, continued making large payouts to these so-called advisors. This is actually a classic example of the “sales centric” culture in our financial advisory landscape wherein advisors are less motivated by the client's interest and more by their own!

Unfortunately, Investors themselves are part of the problem too.

Exotic products (such as structured products, derivative based PMS's and distressed asset funds) have a high degree of appeal to investors who cross a certain net worth and portfolio threshold. Many of these investors get 'bored' by vanilla products such as mutual funds, without realizing that the purpose of investing isn't entertainment, but wealth creation and goal achievement!

Many an intelligent investor has regretted getting locked into exotic products that have failed to deliver returns in the long run, while their less bright counterparts have made better returns in simpler products!

Here are a few reasons why Mutual Funds are a far superior wealth creation engine compared to PMS.

Lack of Transparency

Unlike Mutual Fund performance and portfolio data which is standardized and tightly regulated, PMS data inherently lacks transparency and consistency. Actual holdings may differ from portfolio to portfolio, and so can performance. Moreover, even the data published by SEBI on their website is replete with glaring errors. This was in fact researched and reported by the reputed financial whistleblower platform MoneyLife almost 6 years back. You can read the article here.

For this reason, mis-selling tends to be rampant as there’s no solid maker-checker mechanism in place to ensure that prospective investors are indeed being shown accurate facts and figures. Investors should exercise great caution and not get blindly tempted by the glossy sales collateral offered by PMS products! It would be wise to check back with several existing investors in the product before investing.

High costs

Keep in mind that a PMS is, in essence, a high-cost product. While Mutual Fund expenses are transparently clubbed under the TER or “Total Expense Ratio”, PMS charges are of three kinds: placement charges (one time charges ranging from 1-3% which is basically distributor commission), portfolio manager charges that can vary from 1-3% per annum, and performance linked fees that are typically charged as a percentage of profits earned over a certain threshold (say, 10% of profits earned over 10% and 20% of profits earned over 20%). Put together, these charges may end up being twice as costs associated with Mutual Fund investing. Many people have also pointed out that it’s quite unfair for PMS managers to share in profits when they do not participate in losses!

Tax Inefficiency

Mutual Funds are treated as pass-through entities for taxation. So, the investor is subjected to capital gains (Short /Long etc) only when he buys or sells units of the fund itself. The MF might be churning the portfolio any number of times and this is not taxed and nor does it entail taxes on the investor.

Taxation is different for a PMS product. In a PMS, every trade is treated as if it is being executed by the investor and excess churn by the PMS goes to reduce your effective returns by increasing your tax liability. To this extent, there is a disadvantage in PMS.

Remember, the purpose of investing isn’t “entertainment” or “having fun”. The only true purpose of investing is to meet your financial goals! Instead of chasing returns and exotic products, go back to the basics and set up a fantastic investing process that builds investing resilience. Get started today!