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Mutual funds offer a cost-effective, transparent option for retail investors

DNA Money, October 4th, 2018, Rajesh Cheruvu


When it comes to choosing the appropriate vehicle for investing in equities in the long term, Mutual Funds (MFs) and Portfolio Management Services (PMS) are both ubiquitous.

While both propositions have been pitted against each other, seldom have they been evaluated as "complimentary" to each other. To begin with, both product categories have significant roles to play in investors' wealth creation, purely as differentiated routes with varied degree of attached risk and positioning in tune with risk profile.

While it is imperative to be aligned and well versed with differentiating features, it also important to know the constraints of both alternatives. Both MFs and PMs are collective investment vehicles having their own variation in certain operating principles, target audience, portfolio construct, along with available flexibility in running portfolio strategies.

Mutual Funds

MFs have evolved over the past two decades and have built a historical and comparable performance trail amidst multiple business cycles and ever-changing market conditions. Talking about scale, today, the overall industry has reached a size of Rs 25 trillion, with equity assets of Rs 9 trillion.

On the offerings front, MFs with respective sub-categories, such as large-cap, multi-cap, mid and small-cap portfolios, etc, have witnessed significant divergence in performances. This was predominantly attributed to variation in portfolio composition, construct and lack of uniformity in defining investible market cap universe.

However, the recent categorisation of funds as mandated by Securities and Exchange Board of India, has brought in reasonable amount of standardisation among schemes within each sub-category. Now there appears to be reasonable amount of homogeneity in terms of expected levels of market cap allocations, underlying stock universe, broad nomenclature of schemes and comparable benchmarks, etc. This has reduced the number of funds on offer in each category with overlapping strategies by each fund house and led to the much needed rationalisation of schemes. This has also helped investors choose appropriate funds based on their risk - reward appetite and defined objectives.

In case of MFs, frequent portfolio changes do not impact investors due to realised capital gains, as transactions are done at the scheme level. While, exit from funds would lead to potential capital gains and attract tax basis the holding period.

Portfolio Management Services

PMS are meant for affluent and relatively better-informed investors with a minimum initial allocation of Rs 25 lakh. Asset base of this category is comparatively small when compared with MFs, so is the case with investor base as well.

Although, PMS strategies offer products on similar lines as MFs, the differentiation becomes relatively stark in terms of extent of the flexibility and conviction managers have at their disposal to manage strategies. This cushion, which could bring superior risk adjusted returns, is not available to MF managers. However, one may witness relatively higher volatility in the short term for PMS strategies, given the mandate and portfolio construct.

PMS allows for niche strategies

Having said that, PMS strategies are often used for taking exposures in niche and bespoke strategies, which may not be available with MFs, given the stringent framework and industry landscape. The appeal of PMS strategies lies in being less homogeneous on multiple counts and thus becomes complimentary in many ways. Nimble size of PMS strategies allows them to take concentrated or large exposures in high conviction bets as well, which if fructifies as perceived in the beginning can lead to superior portfolio performance.

From retail investor perspective, MFs would continue to be a cost effective, transparent and preferred choice with simplified and focused fund categories to choose from. While, affluent and High Networth Investors would have choice to make from both buckets basis the relevance and attractiveness of the investment opportunity.

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