Personal Finance | Is there one ‘best’ equity investment product?

Equity asset managers like mutual funds, PMS managers and AIFs are all set up using guidelines as SEBI.

Investing in equity has documented and unequivocal long term benefits. Historical data from practically every stock market, when analysed over decades, supports this faith in the ability of equity to outdo local inflation and generate steady, compounding returns.

The dilemma, however, lies in selecting the vehicle or product to invest in equity. There are way too many options. You can invest directly, but that requires a fair amount of time commitment and also knowledge of stock selection. Or you may choose derivative trading in stocks if there is ability to absorb very high risk.

Alternatively, you have access to managed products like mutual funds, portfolio management schemes (PMS) and alternate investment funds (AIF), which also invest in listed equity and give you the same benefit of long term compounding. As the name suggests, these are managed by qualified fund managers, whose job is to spend time building long term stock portfolios. This is where it all begins to get complicated; there are hundreds of such funds and across more than one type of structure. Recently, there has been a lot of noise in the media about the pointless existence of PMS and AIF structures for investing in equity shares, given that mutual funds allegedly do the best job from a risk adjusted, tax efficient, return perspective.

This seems like a simplistic way to look at a layered issue. It’s almost like saying that because a decidedly ‘superior’ product structure exists, others should shut shop.

There are two aspects to unpack here, should product manufacturers be restricted in what they offer? Can one size (structure) fit all investors?

Asset Managers’ Prerogative

Equity asset managers like mutual funds, PMS managers and AIFs are all set up using guidelines as per market regulator Securities and Exchange Board of India. Which means, SEBI has allowed these different structures to co-exist in the same market place. It also means that they are regulated by SEBI, which has designed the product guidelines and revisits those periodically to ensure that investor interest is kept paramount.

For example, two decades ago a fresh application for mutual fund investments came with an upfront cost which was higher than the annual costs (in the same fund) that kick in from the second year. Today there is no upfront cost and annual expenses have been significantly rationalised lower. Around the same time, there were PMS schemes where you could put in as little as Rs 5 lakh, despite the high risk in concentrated portfolios. Reporting norms for PMS were ad hoc and you often ended up with low quality portfolios, which were churned too much, resulting in a low return and high cost.

Thanks to regulatory supervision, product structures across all these types of managed funds are getting more efficient, there is adequate transparency and guidelines for accessibility only to appropriate investors from a risk perspective are in place.

While mutual funds are open to those who are able to invest just about Rs 500 or Rs 1000 a month, PMS funds are allowed to be offered only to those who can put in at least Rs 50 lakh per scheme and AIFs are meant for those with the capacity of a minimum investment of Rs 1 crore per scheme.

For high net-worth individuals, PMS presents the potential for relatively higher returns from concentrated portfolios, direct visibility of underlying stocks and each trade in the portfolio (PMS investor has to be informed every time there is a trade in the portfolio) and a sense of exclusivity with direct access to fund managers.

Listed equity AIFs come with a predetermined lock in of at least 3-4 years. For you that checks behaviour in times of market panic or euphoria. Moreover, there is no longer a provision for upfront commissions for distributors, hence, conflict in minimised.

It’s the job of a product manufacturer to put options out there, you must pick and choose. After all, there are multiple types of breads, biscuits and wafers, depending on your preference and what you prefer, at the price point you prefer, may or may not appeal to another.

In Comes The Advisor

If you look at PMS returns, the best performing large cap PMS has delivered 40 percent annualised return in the last three years, the best performing mid cap PMS has delivered around 44 percent annualised return and the best performing small cap fund has delivered 105 percent annualised. This compares to 30 percent, 41 percent and 56 percent annualised returns for mutual fund schemes in the same categories for a three year period. The lure of higher return from concentrated portfolios is real. But so is the risk.

However, just like mutual funds, you need to diversify in PMS and AIFs. With high minimum investment size, diversification even with a Rs 5 crore surplus for equity investing, may be more suitable for mutual funds than PMS or AIFs. Moreover, along with having an ability to absorb the selection risk of concentrated portfolios from single fund managers, be mindful that you are moving away from institutionalised processes that mutual funds provide.

The fact that there is a higher tax incidence for PMS portfolios, compared to MFs, gets balanced somewhat, with PMS schemes that have very low churn. Overall, the annual cost in an AIF and fixed fee PMS is comparable to the cost of a regular equity mutual fund plan.

How do you decide which one works? Ideally, with the help of the right advisor who can not only analyse which PMS or AIF scheme is worth your while, both in risk and return, but also how much to allocate. 

The need is not for one perfect managed product for equity investors, because one size never fits all. The need is for better disclosures and perfect transparency in structure, cost, commission and potential return. Given this, the choice of allocation is the advisor’s job, while product manufacturer’s focus remains on giving you multiple options to satisfy your equity hunger.

Lisa Pallavi Barbora is founder of www.MoneyPuzzle.in, besides a personal finance writer, content creator and a coach. Views are personal, and do not represent the stand of this publication.