Investment approach
Also written IA · Investment approaches
A broad outlay of the securities and permissible instruments a portfolio manager will invest in for a client, set out in the PMS agreement and tagged to exactly one strategy.
In plain language
A PMS is not one product. A single portfolio manager may run a large-cap equity approach, a mid-cap approach, a debt approach and a multi-asset approach — each with its own universe of securities, its own style and its own track record.
Each of those is an investment approach. The SEBI (Portfolio Managers) Regulations, 2020 define it as 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. Chapter 9 adds a plainer description: the documented investment philosophy the portfolio manager adopts while managing client funds to achieve the client's investment objectives.
For a PMS distributor it is the unit of sale. Clients do not invest "in a portfolio manager"; they invest in one or more of its investment approaches.
How it works
It is a regulatory requirement in the agreement. The PMS agreement must include the investment approach, areas of investment and any restrictions the client places on investing in a particular company or industry, plus the type of instruments and proportion of exposure (Chapter 7, section 7.5.1; Chapter 8, section 8.3.4; Chapter 9, section 9.3.4). The account opening form records the investment approach and portfolio construction choice opted for.
Strategies and benchmarks (Chapter 9, section 9.3.8).
- SEBI added a layer of broad themes called strategies: equity, debt, hybrid and multi-asset.
- Each investment approach is tagged to one and only one strategy, at the portfolio manager's discretion.
- APMI prescribes a maximum of three benchmarks for each strategy; the portfolio manager selects one of them for each investment approach.
- The Board of the portfolio manager is responsible for appropriate selection of strategy and benchmark.
- Tagging can be changed only after offering subscribers an option to exit without exit load. The track record before the change cannot be used for performance reporting, and the change is verified in the annual audit under Regulation 30.
Performance reporting (Chapter 8, section 8.8). When advertising an investment approach's performance, the portfolio manager presents its TWRR with the trailing return of the selected benchmark. When reporting to an investor, it presents the investor's XIRR for each approach, with the minimum, maximum and median XIRR across all investors in that approach.
A worked example
The portfolio manager and client are illustrative; the rules are the workbook's.
A portfolio manager offers three investment approaches:
| Investment approach | Strategy tag | Benchmark (one of APMI's up to three) |
|---|---|---|
| Large-Cap Quality | Equity | NIFTY 50 |
| Short-Duration Income | Debt | A bond index with similar maturity and credit profile |
| Balanced Allocation | Hybrid | A hybrid index |
Ananya invests ₹60 lakh in Large-Cap Quality. Her agreement records the approach, the instruments and exposure proportions, and her restriction: no tobacco companies.
Two years later the Board decides Large-Cap Quality now belongs under multi-asset. Before changing the tag, the portfolio manager must offer Ananya and every other subscriber an exit without exit load. If she stays, the approach's pre-change track record can no longer be shown in its performance reports — and the change, with its justification, is checked in the annual audit.
Her quarterly report shows her own XIRR, the approach's TWRR, the benchmark's trailing return, and the min/max/median XIRR of all investors in the approach, with the disclaimer that her result may differ because of the timing of her cash flows and her portfolio's restrictions.
Why NISM asks about it
One of the most connected terms in the paper: Chapter 7 (Role of Portfolio Managers, 10%), Chapter 8 (Operational Aspects, 13%) and Chapter 9 (Portfolio Management Process, 15%). Chapter 7's sample question gives the definition and asks you to name it — investment approach, against distractors "investment statement", "investment strategy" and "investment risk profile". The PMS distributor code of conduct in Chapter 12 requires distributors to be fully conversant with investment approaches and to disclose distribution commissions for each.
Common exam traps
- Investment approach is not the same as strategy. Strategy is the broad tag (equity, debt, hybrid, multi-asset); the approach sits beneath it.
- One approach, one strategy. Chapter 9 also contains a garbled sentence saying a portfolio manager "may tag more than one Investment strategy to an investment approach", but the same sentence ends "each investment approach must be tagged to only one strategy". Go with one.
- APMI prescribes up to three benchmarks per strategy; the portfolio manager picks one per approach.
- Changing a tag requires a no-exit-load exit option first, and the old track record cannot be used.
- TWRR is for the approach; XIRR is for the individual investor.
- "Investment policy statement" is a different document — the investor's roadmap, not the manager's product definition.
Check yourself
1.An ________ is a broad outlay of the type of securities and permissible instruments to be invested in by the portfolio manager for the customer, considering factors specific to clients and securities.
- a)investment approach
- b)investment statement
- c)investment strategy
- d)investment risk profile
Show the answer
Answer: (a) investment approach
This is the workbook's definition of an investment approach. It forms part of the client agreement and defines the universe of securities.
"Investment strategy" is the closest distractor but is not the defined term. A risk profile describes the investor, not the securities.
2.In the account opening form format under the Portfolio Managers Regulations, 2020, details such as risk tolerance, investment horizon and withdrawal choice fall under which part?
- a)General information about the client
- b)Investment approach and portfolio construction choice
- c)Investment profile of the client
- d)Introducer details
Show the answer
Answer: (c) Investment profile of the client
The form has three blocks. Investment profile of the client covers “Experience, Risk Tolerance, Investment Horizon, Investment Objective, Withdrawal Choice etc.”
General information is name, mailing addresses, photograph, PAN, driving licence, occupation, introducer details and income details — so introducer details are only one item within general information. The investment approach and portfolio construction choice block records which approach the client has opted for, not the client's own risk profile.
3.Farida joins a PMS by transferring listed shares worth ₹52 lakh on the on-boarding date. Which statement is correct?
- a)The portfolio manager must hold the shares unchanged for at least one year
- b)The shares must first be sold by Farida and the cash brought in
- c)The portfolio manager may sell all or part of the shares to meet her investment objectives within the investment approach
- d)The shares count only at 50% of their value towards the minimum investment
Show the answer
Answer: (c) The portfolio manager may sell all or part of the shares to meet her investment objectives within the investment approach
Investment can be “in cash or in securities or a combination of the two worth minimum Rs. 50 lacs”, with the valuation of the securities on the on-boarding date meeting the regulatory criteria. Then: “The portfolio manager may execute the sale of all or part of such securities to meet the investment objectives of the client within the investment approach.”
There is no lock-in on transferred shares, no need for Farida to sell them first, and no haircut — the workbook values them on the on-boarding date. At ₹52 lakh she meets the ₹50 lakh floor.
Where this is taught
- Series XXI-A · Chapter 7: Role of Portfolio Managersintroduced here
- Series XXI-B · Chapter 7: Role of Portfolio Managersintroduced here
- Series X-A · Chapter 15: Portfolio Construction Processintroduced here
- Series XXI-A · Chapter 8: Operational Aspects of Portfolio Managers
- Series XXI-B · Chapter 8: Operational Aspects of Portfolio Managers
- Series XXI-A · Chapter 9: Portfolio Management Process
- Series XXI-B · Chapter 9: Portfolio Management Process
Related terms
- XIRRExtended Internal Rate of Return: the annualised return on an investment with irregular cash flows, found by assigning a date to each flow. PMS reports it for each investor’s own experience.
- APMIThe Association of Portfolio Managers in India — the PMS industry body that prescribes benchmarks and valuation norms, standardises client documents and registers PMS distributors.
- Exit loadA charge levied when an investor redeems units, calculated as a percentage of NAV and deducted from it, usually only if the units are sold within a stated holding period.
- BenchmarkThe independently published index a scheme's performance is measured against, chosen to match its investment objective, asset allocation and strategy, and disclosed in the Scheme Information Document.
- Portfolio managerA body corporate registered with SEBI that, under a contract with a client, advises on or manages that client's securities or funds — discretionary, non-discretionary or advisory.
- Investment Policy StatementThe written roadmap, drafted with the investor, that sets out objectives, goals, constraints, preferences and risk tolerance. Developing it is the first step of portfolio management.
- Time Weighted Rate of ReturnA compounded return that neutralises client deposits and withdrawals by linking sub-period returns, so it measures the manager’s decisions. Mandatory for PMS investment approach performance.
- Investment constraintsLimits on the investments an investor can take exposure to — liquidity needs, time horizon, regulatory and tax constraints, exposure limits, and unique needs and preferences — recorded in the IPS.
- Customised benchmarkA benchmark built from a portfolio manager's own investment universe, used when no market index fits the manager's strategy or style. Valid, but costly to build and maintain.
- Disclosure DocumentThe document a portfolio manager must give every prospective client with the account opening form, before the agreement is signed, and keep on its website — setting out the manager, services, risks, fees and performance.
- Factor-based investingBuilding a portfolio by selecting and weighting securities on a measurable characteristic such as value, momentum or quality, instead of market size — one route to the asset allocation decision, alongside SAA and TAA.
- Badla financingA traditional Indian carry-forward financing arrangement that a portfolio manager is expressly barred from deploying client PMS funds into, grouped with bill discounting and third-party lending.
- StrategyA SEBI-mandated broad theme, equity, debt, hybrid or multi-asset, that every Investment Approach must be tagged to, each strategy carrying its own prescribed benchmarks.
- Negative list of securitiesA list of securities, companies or industries a PMS client restricts a portfolio manager from investing in, taken at the time the agreement is signed and made part of the account opening form.