Role of portfolio managers — who they are and what they must do

What is portfolio management?

Every investment has two sides: risk and return. Portfolio management means selecting and managing a basket of assets that keeps risk low while trying to keep return high. A portfolio manager designs customised investment solutions for clients.

The legal definition

Learn this one closely. The exam tests its exact words.

Three things to notice:

• It is a body corporate — a company, not an individual.
• It can advise, direct or undertake — so even advice-only services fall inside.
• It covers a portfolio of securities or the client's funds.

Portfolio managers are registered and regulated under the SEBI (Portfolio Managers) Regulations, 2020. Only SEBI-registered entities can offer PMS.

A short history

PMS regulation in India began in January 1993, when SEBI issued the SEBI (Portfolio Managers) Regulations, 1993. These were among the first regulations SEBI ever issued. They came even before the mutual fund regulations. The workbook reads this as a sign of how important SEBI thought the sector was.

The major PMS providers in India are big brokerage firms, asset management companies and independent asset managers.

Three ways to classify PMS

By provider:

1. PMS by asset management companies
2. PMS by brokerage houses
3. Boutique (independent) PMS houses

By product class:

1. Equity based PMS
2. Fixed income based PMS
3. Commodity PMS
4. Mutual fund PMS
5. Multi asset based PMS

Portfolio managers may also classify clients by net worth.

By service — the classification that appears in the regulations themselves. This is the one that matters most.

Discretionary, non-discretionary and advisory

Discretionary. The regulation says a discretionary portfolio manager "exercises or may exercise, any degree of discretion" over the client's investments. In plain words, the manager individually and independently manages each investor's money under the contract. It can follow an existing investment approach or be customised.

Non-discretionary. The manager follows the client's directions. It does not use its own judgement on buying or selling. It must consult the client for every transaction. "What to buy or sell" and "when" are the investor's decisions. The manager only executes. So it provides execution services, not investment management services.

Advisory. The manager suggests ideas or gives non-binding advice. The investor decides and the investor executes. The workbook says this is typically used by institutional clients who manage their own portfolios but hire country experts.

The general responsibilities

The regulations list eleven responsibilities. Group them to remember them.

How money is managed

1. A discretionary manager manages each client's funds individually and independently, in a manner that does not partake the character of a mutual fund. A non-discretionary manager follows the client's directions.
2. Minimum ₹50 lakh in funds or securities per client. This applies to new clients and fresh investments by existing clients. It does not apply to an accredited investor (with disclosure and agreed terms), or to the co-investment portfolio manager.
3. Act in a fiduciary capacity for the client's funds.

Keeping client assets apart

4. Keep each client's securities in separate accounts.
5. Keep all clients' funds in a separate account in a Scheduled Commercial Bank.

Staying within limits

6. Deal in securities within the limits the client sets, under the Reserve Bank of India Act, 1934.
7. No direct or indirect benefit from client funds or securities.
8. No borrowing of funds or securities on the client's behalf.
9. No lending of client securities to a third person, except as the regulations allow.

Service and distribution

10. Handle client complaints properly, on time, and act immediately.
11. Make sure its distributors follow the regulations and circulars.

Administering the client's portfolio

Two execution models:

• Pool execution — trade for all clients together, then allocate securities to each client's demat account.
• Individual execution — trade in each client's name. Allocation happens automatically.

The written agreement comes before any money is managed. It sets out mutual rights, liabilities and obligations.

The universe of securities. The agreement includes the investment approach — "a broad outlay of the type of securities and permissible instruments to be invested in", considering factors specific to clients and securities. It also includes any client restrictions on a company or industry. So the universe of investable securities is defined in the agreement. This is a regulatory requirement.

Premature withdrawal. Clients can withdraw before the contract matures, on the terms in the agreement. The agreement must state withdrawal fees as a percentage and as an amount. Portfolio managers cannot impose a lock-in. Under the PMS circular of 13 February 2020, the maximum exit load is 3% in year 1, 2% in year 2, 1% in year 3, and nil after three years, on the amount redeemed.

Dos and Don'ts

Dos include: resolve grievances within 21 calendar days of receiving the complaint and keep SEBI informed; follow the Code of Conduct; keep client securities and funds separate (including from the manager's own funds and securities); be responsible for safekeeping.

Don'ts — the thirteen the workbook lists:

1. No direct or indirect benefit from client assets
2. No borrowing on the client's behalf
3. No lending client securities to third persons, except as the regulations allow
4. No investing client money except as the agreement allows
5. No distribution-related fees when investing in direct plans of mutual funds
6. No leverage of client portfolios for derivatives
7. No use of client funds for bill discounting, badla financing, or lending or placement with corporate or non-corporate bodies
8. No investing client funds in a portfolio run by another portfolio manager
9. No investing client funds on the advice of any other entity
10. No speculative transactions — nothing settled other than by actual delivery, except derivatives
11. Buy and sell separately for each client ordinarily. If aggregated for economy of scale, allocate pro rata at the weighted average price of the day. No open position in allocation at day end
12. No holding client securities in its own name
13. No off-market transfers in client accounts, except: settling the client's own trades; margin or collateral for the client's own positions; unlisted securities as per regulations; specific client consent for each transaction; or other reasons SEBI specifies

Custodian, records, audit and compliance officer

Custodian. Every portfolio manager must appoint a custodian, except one that provides only advisory services. Custodian details — name, address, SEBI registration number, date of appointment — go into the registration application. (Chapter 12 adds a second exemption: the co-investment portfolio manager.)

Records. Keep: balance sheet, profit and loss account and auditor's report for each accounting period; a statement of financial position; and records supporting every investment decision — the data, facts and opinion behind it. These are maintained under the Principal Officer. Tell SEBI where records are kept. Preserve records for the preceding five accounting years. Give SEBI a net worth certificate from a chartered accountant when asked.

Accounts and audit.

• Keep separate client-wise accounts, including all credits (interest, dividend, bonus) and debits.
• Record TDS under the Income-tax Act, 1961 in the portfolio account.
• Books audited yearly by a qualified auditor. A certificate, if SEBI requires, goes to SEBI within six months of the close of the accounting period.
• Portfolio accounts audited annually by an independent chartered accountant; the certificate copy goes to the client.
• The client may appoint their own chartered accountant to audit their transactions, and the manager must co-operate.

Compliance officer. Monitors compliance with the Act, rules, regulations and SEBI or Central Government instructions, and handles investor grievances. Must immediately and independently report any non-compliance to SEBI.

A gap you should know about

The workbook's own sample question asks for the net worth requirement for PMS registration. The chapter text does not state the figure. We have not supplied one from outside the workbook. Check the current SEBI (Portfolio Managers) Regulations, 2020 before your exam if you want that number.

Beyond the book

The ban on managers taking a benefit from client money and the rule on separate client bank and demat accounts exist because pooling is where things go wrong. In India, the Karvy Stock Broking case of 2019 — where a broker misused client securities held under power of attorney — is the best-known recent example of what happens when client assets are not kept apart.