Managed portfolio

There are two ways to own securities. You can buy them yourself, or you can hand the money to someone whose job is to buy them for you.

The first is direct investment. You buy the share, the bond or the gold, and it is yours.

The second route goes through a managed portfolio. A vehicle collects money from many investors, invests it in a range of securities, and is run by professionals. What you own is a share of the vehicle, not the individual securities.

The workbook names four such vehicles in India: mutual funds, alternative investment funds, portfolio managers and collective investment schemes.

The reason to use one is cost. A small investor cannot hire a research team. Through a managed portfolio the same expertise is available at a much lower cost, shared with everyone else in the pool.

Section 7.9 splits the channels for making investments into direct investments and investments through managed portfolios. In the second, investors put money into vehicles which pool money from investors and invest in a variety of securities and other investments on their behalf — in other words, investors make indirect investments. These vehicles are professionally managed, and through them investors avail the professional expertise at much lower costs.

The four the workbook lists: Mutual Funds (MFs), Alternative Investment Funds (AIFs), Portfolio Managers (PMs) and Collective Investment Schemes (CISs).

How the first three compare, from the workbook's own contrast:

The workbook's reasoning for the difference is not the size of the fund but the investor. Mutual funds cater to retail investors and are therefore more stringently regulated; AIF and PMS investors are expected to understand complex investment strategy and risks involved, so the regulation is lighter and the restrictions fewer. The workbook records the market's own nickname: AIFs and PMS are popularly referred to as the rich man's mutual fund.

One structural point that the minimums hide: in a PMS the client owns the securities in his own name, while in a mutual fund or AIF the investor owns units and the vehicle owns the securities.

Illustrative figures. Three clients want Indian equity exposure and reach three different doors.

Now the same money invested directly. Deepa would have to pick, buy and monitor 25 shares herself with Rs 10,000 a month — she cannot buy a diversified basket at that size, and she has no research desk. Through a mutual fund her Rs 10,000 buys a slice of a portfolio worth thousands of crores, and the fund manager's cost is spread across every unitholder. That is the "professional expertise at much lower costs" the workbook means.

And the trade she makes for it: she no longer chooses the individual shares. Mr Shah, at Rs 60,00,000 through a PMS, does own the shares in his own name — but he too has handed the decisions to the manager.

If Mr Shah had only Rs 40,00,000, the PMS door is shut: the portfolio manager may not accept funds or securities worth less than Rs 50 lakh. He would be back to mutual funds, whatever his sophistication.

Chapter 7 (Introduction to Investments), section 7.9 (Channels for making investments), which sets direct investment against managed portfolios and then compares mutual funds, AIFs and portfolio managers. Expect a question asking which of a list is a managed portfolio, or one on the minimum investment amounts — Rs 1 crore for an AIF against Rs 50 lakh for PMS — and on why mutual funds are more stringently regulated.

• Four vehicles, not three. Collective Investment Schemes are on the workbook's list alongside MFs, AIFs and PMs.
• Rs 1 crore is the AIF minimum; Rs 50 lakh is the PMS minimum. Swapping them is the commonest slip in this chapter.
• All four are SEBI-regulated. Light-touch is not unregulated.
• The reason mutual funds are regulated harder is the investor, not the product. They cater to retail investors.
• Managed does not mean actively managed. An index fund is still a managed portfolio in this sense: the money is pooled and professionally run.
• Buying gold or silver from a dealer is direct investment, even though it is not a security. The workbook's direct-investment list includes commodities.