Risks Of Investing In PMS: What Investors Must Know Before Choosing Portfolio Management Services

Portfolio Management Services are sophisticated investment products designed to provide wealthy individuals with tailored solutions that may deliver better performance than traditional mutual funds. However, even if you are an HNI (High Networth Investor), there are a few risks that you cannot ignore while investing in PMS. It is important to carry out a risk-return assessment and then decide whether PMS can be a good investment alternative for you. 

While most retail investment products offer diversified investments and lower risk, PMS have custom portfolios and concentrated stock holdings. Therefore Risks of investing in PMS are higher. The Securities and Exchange Board of India has defined PMS as a product for "sophisticated" investors who can evaluate their risk tolerance and bear increased volatility. Therefore, before investing in a PMS, an investor must evaluate the specific risks associated with it. 

What Is PMS Investing?

Managed by qualified financial professionals, PMS is a way for investors to have a customized portfolio of securities created and managed for them. With PMS, all assets are owned individually by the investor and will be recorded in their own "demat" account rather than being pooled together as investors do with mutual funds.

Let’s consider an investor who invests INR 75 Lacs in a wealth management firm that manages a portfolio of mid-cap stocks. The manager will create a group of 15-20 stocks based on his investment strategy; the asset allocation will be determined solely by the securities selected for the manager’s portfolio. 

PMS portfolios often contain fewer securities than traditional mutual fund portfolios. While a typical mutual fund may own between 40 and 60 different stocks, PMS portfolios usually have fewer than 25 assets, which increases the overall price risk of PMS investments and the potential to earn higher returns than conventional mutual funds. 

Minimum Investment Requirements

In accordance with SEBI regulations, the minimum permitted investment for PMSs in India is INR 50 lakh, thereby making PMSs available only to wealthy investors. The minimum requirements for PMSs do not mitigate the risks associated with their use. It increases the potential concentration of assets invested in a single strategy under a single manager. 

In other words, the PMS minimum investment risk is minimal, stemming from the exposure of a large lump sum to a single manager and a single strategy. It creates dependency risk.

Major Risks of Investing in PMS

The biggest risks of investing in PMS may be concentration risk. Since portfolios in PMS are designed to be focused, a few stocks within the PMS underperforming could lead to significant losses.

Because of this concentration of stock in PMS and less concentration in mutual funds, these two forms of investing carry different risk characteristics. Thus, while mutual funds diversify risk across many different types of securities, PMS increases risk through the concentrated risk associated with individual stock holdings.

Manager Performance Dependency

A significant PMS investment disadvantage is the reliance on an individual fund manager's expertise. The returns are highly correlated with a fund manager's stock selection ability and market timing. This disparity creates a PMS volatility risk in portfolio management services for Indian investors.

Liquidity, Cost And Transparency Risks

The PMS fee structure is considerably more complex than that of a Mutual Fund. Some examples include:

• Fixed Management Fees (typically 1–2.5% yearly.
• Performance Fees (10–20% profit share above certain hurdle rates)

If an investor earns an 18% gross return in a given year, they will likely have 4–5% deducted for management and performance fees, yielding a net return of 14–15%. Compounding fees significantly reduce the wealth created over time.

In PMS vs mutual fund risk, which typically have expense ratios of 0.5–2%, PMS investments are disadvantaged by higher fees.

Lock-in and Exit Challenges

While PMSs typically lack the stringent locking periods of ELSS funds, investors may face early exit fees or have to wait longer than expected to redeem their investments. During bear markets, liquidity in an underlying stock can become an issue if it's an illiquid mid-cap or small-cap, further increasing investment risk for PMS investors who may want to access their funds in an emergency.

How Investors Can Reduce PMS Risks

Investors can reduce their risk through strategic planning, despite the inherent risks of investing in PMS.

Investors need to diversify their investments across multiple asset classes. Instead of dedicating all their capital to a single PMS strategy, investors should allocate capital across debt securities, index funds, and other alternative asset classes. Common Crypto Mistakes Made by New Investors. The principle of diversification is essential to PMS investing.

To evaluate PMS performance, investors must consider rolling returns over 3–5 years, the upside-to-downside ratio, maximum loss, and a comparison to an appropriate benchmark. Aspects of the portfolio turnover ratio and the portfolio's sector makeup are also required to assess performance accurately.

Another strategy for investing through a PMS is to select one that aligns with the investor’s risk/return profile. A high-growth mid-cap PMS may not be appropriate for an investor who is conservative about capital preservation.

Finally, understanding and accepting the risks of PMS in India before investing will help reduce emotional investment decisions during periods of uncertainty and price volatility.

Conclusion

PMS has the same basic risks as investing: lack of diversification, reliance on the manager, higher costs, and limited liquidity. Although PMS provides investors with customized products, it also exposes them to higher volatility and a greater risk of loss than other investment vehicles. Portfolio management services risks India are generally recommended only for financially strong investors who are willing to accept short-term losses & have an investment horizon of at least 5 years. Investors must perform their own due diligence & diversify when using these investment vehicles to avoid risks associated with PMS volatility.

Visit Grip Invest today!

FAQs

1. Is PMS investment risky?

Yes, PMS carries a higher risk than mutual funds due to concentrated portfolios, manager dependency, and higher volatility.

2. What is the minimum investment for PMS?

As per SEBI regulations, the minimum investment required for PMS in India is INR 50 lakh.

3. How is PMS different from mutual funds?

PMS offers customized portfolios held in the investor’s demat account with concentrated holdings, while mutual funds pool money into a diversified common portfolio.

4. Are PMS returns guaranteed?
No, PMS returns are market-linked and not guaranteed. Performance depends on stock selection, market conditions, and the manager’s strategy.

5. Who should ideally invest in PMS?
PMS is generally suitable for high-net-worth investors with a high risk appetite and a long-term investment horizon of at least 5 years.

6. Can PMS underperform mutual funds?
Yes, PMS can underperform mutual funds, especially during market downturns, due to concentrated holdings and higher volatility.

Want to stay at the top of your finances? 

Join the community of 4 lakh+ investors and learn more about Grip Invest, the latest financial knick-knacks, and shenanigans in the world of investing.

Happy Investing!

Disclaimer - Investments in debt securities/municipal debt securities/securitised debt instruments are subject to risks including delay and/ or default in payment. Read all the offer related documents carefully. The investor is requested to take into consideration all the risk factors before the commencement of trading.
This communication is prepared by Grip Broking Private Limited (bearing SEBI Registration No. INZ000312836 and NSE ID 90319) and/or its affiliate/ group company(ies) (together referred to as “Grip”) and the contents of this disclaimer are applicable to this document and any and all written or oral communication(s) made by Grip or its directors, employees, associates, representatives and agents. This communication does not constitute advice relating to investing or otherwise dealing in securities and is not an offer or solicitation for the purchase or sale of any securities. Grip does not guarantee or assure any return on investments and accepts no liability for consequences of any actions taken based on the information provided. For more details, please visit www.gripinvest.in

Registered Address - 106, II F, New Asiatic Building, H Block, Connaught Place, New Delhi 110001