Mutual funds to gain as Sebi tightens norms for portfolio managers

The new norms on portfolio management services (PMS), introduced by the Securities and Exchange Board of India (Sebi) on Wednesday, may further tilt the playing field in favour of mutual funds (MFs), say industry players.

While the regulator’s board has approved of broader changes, such as a 2.5x increase in net worth to Rs 5 crore and doubling of minimum ticket size to Rs 50 lakh, it is in the process of enacting other changes through circulars to standardise performance reporting and fee structure, cap operational costs, and tightly regulate the industry.

So far, portfolio managers, who cater to rich investors, enjoyed a relatively lenient regulatory framework over MFs, thus providing them greater flexibility to operate and levy fees. However, the new rules are likely to take off some edge.

Sebi has said it will soon tweak the fee structure of PMS players. While the regulator has refrained from capping fees, such as in the case of MFs, it will direct service providers to be more transparent. “PMS players will have to disclose a range of fees in client documents. This will help investors know whether they are being charged at the low end or the high end,” said Madhabi Puri Buch, whole-time member, Sebi.

The regulator will also prescribe a formula for profit sharing. Besides fees, PMS players typically have a profit-sharing clause, based on which investors have to share a portion of the gains with the service provider if the returns cross a set benchmark. 

At present, most players used the so-called ‘high water mark principle’, which is the point where a portfolio reaches its highest value. 

However, PMS providers use different methods to compute the high water mark, which the regulator will standardise to remove any discrepancy.  Performance reporting of PMS players is also set to undergo a sea-change. Sebi will soon mandate them to use a time-weighted rate of returns (TWRR) by including the cash and liquid investments. 

The performance will have to be reported net of all fees, taxes, and expenses. This will help investors get the real return picture.

Some PMS players use arbitrary methods to showcase performance, and will have to maintain a standard way. Performance reporting will have to be consistent in the marketing material, given it is made by Sebi.
 

CHANGE IN RULES

• Returns to be reported net of all expenses, taxes
• Direct plans to be introduced
• Operational cost to be capped at 50 bps
• Performance reporting to be standardised
• Profit sharing norms to be tightened
• Cap on transactions done through associate broker

Sebi will ask PMS providers to cap operational expenses at 0.5 per cent, excluding the brokerage. In a move that could hit distributors, Sebi will mandate all players to provide an option of direct plans to investors. 

The move is similar to that implemented in the MF industry. The exit load will be capped on the duration of the portfolio, and investors will have to be informed about the load structure in advance. 

Sebi will also cap the transactions a PMS provider undertakes through a broker, which is an associate company, at 20 per cent. Many PMS providers undertake a bulk of transactions through brokerages that are associate firms belonging to the same group, at present. 

To reduce concentration risk, Sebi has said that only a fifth of the transaction will be allowed per associate in a calendar quarter. Most of the changes are based on recommendations made by a working group. 

Industry players say current PMS investors with a relatively low ticket size could shift to fund houses. 

“From a diversification angle, investors usually limit their exposure to 10-20 per cent of their overall portfolio value in a single PMS product. The increase in investment size to Rs 50 lakh implies that assuming a 20 per cent allocation to individual PMS, only investors with portfolio size above Rs 2.5 crore will be interested. Current investors in the PMS segment, especially with overall portfolio size of Rs 1.0-2.5 crore may shift towards the MF space,” said Arun Kumar, head of research, FundsIndia.com. Some said higher net worth requirement for MFs as well as PMS providers could give birth to a new breed of fund managers.

"The PMS or MF licenses are only two of many ways that Sebi allows investment professionals to showcase their research and create investable products. The other 2 common ones are research analysts (RAs) and registered investment advisors (RIAs). These licenses have a lower net-worth requirement and setup costs. The latest directives could encourage more investment professionals to apply for the RIA or RA license, and create readymade portfolios with investor discretion for their clients," said Vasanth Kamath, CEO & co-founder, Smallcase Technologies.