image credits: Prabhudas Lilladher
There are lots of individuals who understand the need to invest their money in the lucrative stock market but are unable to do so because of either lack of confidence, lack of risk capacity, or lack of knowledge altogether. So these investors can approach money managers so that they can invest this money on behalf of these individuals.
Based on the type of returns and investments they will be expected to invest in, investors have the options to invest their money in
- mutual funds
- portfolio management services
- hedge funds
We will only be discussing the first two in this article as there aren't many hedge funds successfully running in India, and these two will be the most likely choices an investor will get to invest in.
Comparing mutual funds (MF) and portfolio management services (PMS)
While these two may be similar firms to park your capital in, as in they broadly invest in similar instruments, there are many factors that one must consider before choosing either of the above.
- The minimum capital to invest: Mutual funds require a minimum capital of as little as ₹500, while Portfolio Management Services require a minimum capital of ₹50 lakh from investors. This can make the latter an expensive option for many investors.
- Companies invested in: Investors are presented with various types of mutual fund plans like large-cap, mid-cap, small-cap, IT-specific, insurance-specific, etc. PMS generally invests in riskier micro-cap or small-cap companies only, in the bid to make higher returns for their investors.
- Expected returns: Mutual fund investors tend to underperform the market, and few have a track record of having made a sizeable profit. PMS are keen on making a sizeable return for the risks they are taking on the micro-cap companies.
- Markets where cash can be deployed: Both Mutual funds and PMS are only allowed to invest in cash markets. After recent developments, both mutual funds and PMS are now allowed to hedge their equity positions in the futures and options (F&O) market on a 1:1 ratio. This means that for example, if they buy 1000 shares of Reliance in the cash market, they can hedge it by selling call options of quantity 1000. Also, both mutual funds and PMS are now allowed to sell Nifty 50 call options.
- Commission and management fees: Mutual funds require paying a management fee of just around 1% while PMSs require paying for as much as 1.5%-2.5% in entry fees alone, without even considering management fees and profit sharing.
- Nature of services: Mutual funds tend to offer a fixed type to service for a lot of customers while portfolio management services tend to offer customized portfolios for a few set of customers who can afford these services.
- Transparency: While SEBI is working towards ensuring better transparency of portfolio management services in India, mutual funds have been known for their transparency for multiple decades and are much more reliable in this aspect.
- Handling of portfolio: PMS can be of two types - discretionary and non-discretionary. In the former, the portfolio manager can take investment decisions directly and manage the demat account of the investor, while in the latter, the manager merely suggests investment ideas and the implementation of the investment is up to the investor himself/herself. Mutual funds tend to be discretionary only.
- Tax efficiency: Another advantage of mutual funds on the regulatory side is the minimal taxes they have to pay. Mutual fund investors are only obligated to pay the long-term capital gains tax of 10% if they hold their investment for more than a year. On the other hand, portfolio management services have to shell out 30% on dividends earned, 15% short-term capital gains tax, and 10% long-term capital gains tax, putting pressure on PMS firms to take more risks to overcome this tax liability.
There are many pros and cons to choosing between a mutual fund and a portfolio management service and all these points should help each individual with their decisions regarding their risk capacity, financial standing, and long-term wealth goals.