SEBI's glitzier funds can doom PMSes

Dark clouds loom over the PMS (short for Portfolio Management services) industry. Ever since SEBI, the capital markets regulator, proposed on Tuesday (July 16, 2024) to build a slightly more gentrified version of mutual funds, PMSes appear shaky.

Here's why:

• Lower entry barrier: While a potential investor needs at least Rs 50 lakh to invest in PMSes, the new asset class will require a significantly lower amount. As of now, SEBI proposes a minimum investment of Rs 10 lakh.
  
• Broad-ish investment mandate: Although PMSes have a plethora of investing strategies, the 'new asset class' will not be far behind. As of now, SEBI has suggested two investment strategies for the new investment option:
  
• Long-short equity fund: Depending on the view on markets and sectors, it can go long in one sector and short in another. For example, it can invest in both the Financials and Pharma sectors by going long (buy) in one sector and short (sell) in the other.
  
• Inverse ETF/Fund: In this case, if Nifty 50 falls by 1 per cent, the fund gains 1 per cent.
  
• Moreover, derivatives will likely be used for hedging, portfolio rebalancing, and taking long and short positions. However, leverage will likely not be permissible.
  
• If SEBI has its way, the investment ceiling will also be relaxed. For instance, the new product will be able to have up to 15 per cent stake in a company and up to 15 per cent net assets in a company. The corresponding limit for mutual funds on both counts is 10 per cent. In the case of debt, there will be a 25 per cent sectoral limit against mutual funds' 20 per cent.
• Better tax structure: As the new investment option will be under the broader umbrella of mutual funds, it will enjoy a tax advantage over PMSes. Unlike PMSes, where investors bear the tax liability for every sale the fund manager makes, this new asset class will only tax the investor when withdrawing their investment. In other words, it will only attract a one-time tax.
  
• Greater liquidity: Like a mutual fund, investors will be able to redeem their investments as per their requirements. SEBI proposes SWP (systematic withdrawal plans) and STP (systematic transfer plans) features, which are music to investors' ears. PMSes, on the other hand, are usually stricter when it comes to investment redemptions.
  
• Trusted fund managers: The new product can only be operated by existing mutual fund houses. They need to have a strong track record, where they should have been operating for at least three years with average assets of at least Rs 10,000 crore in the last three years.
  
  The other option is for the chief investment officer (CIO) to have over 10 years of experience managing funds with over Rs 5,000 crore of total assets. SEBI has also laid down guidelines for an additional fund manager. They should have more than 7 years of experience managing funds with at least Rs 3,000 crore in total assets.
• Greater transparency: Portfolios will have to be disclosed each month. On the other hand, PMSes have no such periodical obligations to make their portfolios public.

Our take

If the new product materialises in its current form, it will give PMSes a run for their money, as they offer the best of both worlds: the risk-taking capabilities of a PMS and the regulations, transparency and tax treatment of a mutual fund.

As such, one of two things is likely to happen to the 396 existing PMSes: The ones with a good track record are likely to try and get a mutual fund licence and offer the new asset class. Or, the poor performers will see outflows as knowledgeable investors switch to a more transparent and tax-efficient product.

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