Role of Portfolio Managers — the ground floor

What a portfolio manager actually is

A mutual fund pools everyone's money into one basket. A portfolio manager does something different. It looks after one client's portfolio at a time, under a contract with that client.

The workbook's definition is worth reading slowly. A portfolio manager is a body corporate which, under a contract or arrangement with a client, advises or directs or undertakes on behalf of the client the management or administration of a portfolio of securities or the client's funds. It may do this as a discretionary portfolio manager or otherwise.

Three things follow from that sentence:

• It must be a body corporate. An individual cannot be a portfolio manager.
• There must be a contract with each client.
• The service can be advice, direction or actual management.

Portfolio managers are registered and regulated under the SEBI (Portfolio Managers) Regulations, 2020. Only SEBI-registered entities can offer portfolio management services (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 regulator's first regulations — they came even before the mutual fund regulations. The workbook reads this as a sign of how important SEBI considered the sector.

In India the major providers are big brokerage firms, asset management companies and independent experts.

Ways to classify PMS

By who provides it:

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 their net worth. But the classification that appears in the regulation itself is by the service provided. There are three.

The three services

Discretionary. The regulation says a discretionary portfolio manager is one who "exercises or may exercise, any degree of discretion" over the investment of funds or management of the client's portfolio. It manages each investor's money individually and independently as per the contract. The approach can be an existing strategy the manager offers, or it can be customised to the client.

Non-discretionary. The manager follows the client's directions. It must consult the client for every transaction. "What to buy or sell?" and "When to buy or sell?" rest with the investor. The manager only executes. So the workbook says it provides investment execution services but not investment management services.

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

Why "body corporate" matters

The term comes from Section 2(11) of the Companies Act, 2013. A body corporate includes a company incorporated outside India, but does not include:

• a co-operative society registered under a co-operative societies law, and
• any other body corporate (not being a company under the Act) that the Central Government notifies.

In simple terms it covers a private company, public company, one person company, small company, Limited Liability Partnership, foreign company and so on. The core idea is a separate legal existence apart from the people who form it.

Getting registered

A certificate of registration from SEBI is mandatory. The application is filed online on the SEBI Intermediary Portal, in Form A of Schedule I, with a non-refundable fee.

Form A is long. Its parts cover particulars of the applicant, organisation structure, infrastructure, a business plan for three years, financial information (including a net worth certificate not older than 3 months), other information (disputes and economic offences in the previous 3 years), business information (risk profiling procedure, grievance mechanism, approved brokers, accounting system), experience, additional information (draft client agreement, draft disclosure document, custodian details) and declarations. The list of major shareholders asks for those holding 5% or more voting rights. The compliance declaration must be signed by at least two directors or designated partners.

SEBI may ask for more information, and the applicant or its principal officer may have to appear in person.

What SEBI checks before granting registration

The principal officer

The principal officer is the employee responsible for (A) the decisions made for managing the client's portfolio or funds, and (B) the overall supervision of the portfolio manager's operations.

The principal officer needs all three of:

• Qualification — a professional qualification in finance, law, accountancy or business management from a recognised university or institution (or a foreign university), or NISM's Post Graduate Program in the Securities Market (Portfolio Management) of not less than one year, or a CFA charter.
• Experience — at least five years in related securities market activities (portfolio manager, stock broker, investment adviser, research analyst or fund manager). Of this, at least 2 years must be in portfolio management, investment advisory or areas related to fund management.
• Certification — the relevant NISM certification specified by SEBI.

The other employee

Besides the principal officer and compliance officer, the applicant must employ at least one person with graduation and at least two years of related securities market experience. And any employee with decision-making authority on fund management must meet the same qualification, experience and certification as the principal officer.

Once granted, the certificate is valid unless suspended or cancelled by SEBI.

General responsibilities

The Regulations list these:

1. A discretionary manager manages each client's funds individually and independently, in a manner which does not partake the character of a Mutual Fund. A non-discretionary manager follows the client's directions.
2. Minimum investment: ₹50 lakh. The manager shall not accept funds or securities worth less than fifty lakh rupees. This applies to new clients and to fresh investments by existing clients. It does not apply to an accredited investor (subject to disclosure and agreed terms), nor to a co-investment portfolio manager.
3. Act in a fiduciary capacity with regard to client funds.
4. Segregate each client's securities in separate accounts.
5. Keep all clients' funds in a separate account in a Scheduled Commercial Bank.
6. Transact within the limits the client places under the RBI Act, 1934.
7. No direct or indirect benefit from client funds or securities.
8. No borrowing of funds or securities on behalf of the client.
9. No lending of client securities to a third person, except as the regulations provide.
10. Handle client complaints properly, promptly and act immediately.
11. Ensure anyone distributing its services complies with the regulations.

Administering the portfolio

Two execution models. In pool execution, the manager trades for all clients together and then allocates securities to each client's demat account. In the other model it trades in each client's name, so allocation is automatic.

The written agreement comes before taking up the assignment. It sets out mutual rights, liabilities and obligations.

Investment approach. The agreement includes the investment approach — "a broad outlay of the type of securities and permissible instruments to be invested in by the portfolio manager for the customer, taking into account factors specific to clients and securities". It also includes any restrictions the client imposes on a company or industry. So the universe of securities is defined in the agreement, and 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 dated February 13, 2020, the exit load on partial or full redemption is capped:

Do's and don'ts

Do's include: redress investor grievances within SEBI's time and keep SEBI informed of complaints; abide by the Code of Conduct; segregate client securities; keep client funds in a Scheduled Commercial Bank; stay within client limits under the RBI Act; keep client funds and securities separate from its own and be responsible for their safekeeping.

Don'ts — the ones most often tested:

• No benefit from client money; no borrowing; no lending of securities (except as allowed).
• Invest only in terms of the agreement.
• When investing in mutual funds through a direct plan, charge no distribution-related fees.
• No leverage of client portfolios for investment in derivatives.
• No bill discounting, badla financing, or lending or placement with corporate or non-corporate bodies.
• Do not invest client funds in a portfolio managed by another portfolio manager.
• Do not invest based on the advice of any other entity.
• No speculative transactions — nothing settled otherwise than by actual delivery, except derivatives.
• Ordinarily buy or sell separately for each client. If purchases or sales are aggregated for economy of scale, allocate pro rata at the weighted average price of the day's transactions, and keep no open position in allocation.
• Do not hold client securities in its own name.
• No off-market transfers in client accounts except: settling the client's own trades; margin or collateral for the client's own positions; dealing in unlisted securities as per regulations; specific consent of the client for each transaction; or any other reason SEBI specifies.

Custodian, records, audit and compliance officer

Custodian. Every portfolio manager except one providing only advisory services must appoint a custodian for the securities it manages or administers.

Records. It must 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 transaction or recommendation showing the data, facts and opinion behind the decision. It must tell SEBI where these are kept, send SEBI the balance sheet and P&L after each accounting period, furnish a CA-issued net worth certificate when required, and preserve records for the preceding five accounting years.

Accounts and audit. Separate client-wise accounts, with all receipts (interest, dividend, bonus) and expenses reflected. TDS under the Income-tax Act, 1961 is recorded in the portfolio account. Books are audited yearly; portfolio accounts are audited annually by an independent chartered accountant, with a copy of the certificate given to the client. The client may appoint its own CA to audit its transactions, and the manager must co-operate. For firm-level performance audit, all client portfolios — discretionary and non-discretionary — are considered, on terms of reference set in consultation with APMI (Association of Portfolio Managers of India).

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