Portfolio manager

A portfolio manager is a body corporate which, pursuant to 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. Portfolio managers are registered and regulated under the SEBI (Portfolio Managers) Regulations, 2020, and portfolio management services may be offered only by SEBI-registered entities.

The service comes in three grades, and the difference is who decides and who executes:

• Discretionary — the manager exercises discretion over investment of the funds, managing each client's money individually and independently, in a way that does not partake of the character of a mutual fund.
• Non-discretionary — the manager manages in accordance with the client's directions. What to buy or sell, and when, rests with the investor; the manager executes.
• Advisory — the manager offers non-binding investment ideas. The investor decides and executes. Typically used by institutional clients.

India's PMS regulations date from January 1993 — they came before the mutual fund regulations.

The registration and conduct rules carry the numbers the paper asks for.

To register: a body corporate; certificate of registration from SEBI; application in Form A of Schedule I with a non-refundable fee; adequate office space, equipment and manpower; a compliance officer; a principal officer with a professional qualification in finance, law, accountancy or business management, at least five years' experience in related securities-market activities and the relevant NISM certification; at least one further employee who is a graduate with two years' experience; net worth of Rs 5 crore; and a fit and proper person throughout.

Once registered: the portfolio manager shall not accept from a client funds or securities worth less than Rs 50 lakh. It must act in a fiduciary capacity with regard to the client's funds, segregate each client's holdings in separate accounts, and keep all clients' funds in a separate account with a scheduled commercial bank. It may invest a maximum of 30% of a client's portfolio in securities of its own associates or related parties, and only with a one-time written consent. It may not invest in below-investment-grade securities, may not borrow funds or securities on the client's behalf, may not lend client securities except as provided, and may not derive any direct or indirect benefit out of client funds.

Fees come in two layers — a fixed fee, and a performance-linked profit share governed by a hurdle rate (the return below which no profit share arises), a high water mark (the previous highest value on which fees were charged) and a catch-up / no catch-up term deciding whether the share is computed on all the gains or only those above the hurdle. Returns are computed per financial year.

Mr Rao places Rs 80,00,000 with a discretionary PMS — comfortably above the Rs 50 lakh regulatory minimum. The terms: 1% fixed fee, plus a 20% profit share above a hurdle rate of 8%, no catch-up, subject to a high water mark.

Year 1: the hurdle of 8% on Rs 80,00,000 is Rs 6,40,000, putting the hurdle value at Rs 86,40,000. Under a no catch-up term only the excess counts — 96,00,000 − 86,40,000 = Rs 9,60,000 — so the share is Rs 1,92,000. The high water mark is now Rs 96,00,000.

Year 2: the portfolio falls. No profit share, because the value is below the high water mark. The 1% fixed fee is still charged, in this year as in every other.

Year 3: the return of 15.9% clears the hurdle, and Rs 1,02,00,000 clears the high water mark of Rs 96,00,000 — so a share arises, but only on the Rs 6,00,000 above the previous high.

The last line is the whole reason the principle exists. Without a high water mark the year 3 base would have been the full Rs 14,00,000 of the year's gain and the fee Rs 2,80,000 — meaning Rs 1,60,000 of it was a second charge for recovering ground the client had already paid for in year 1.

Chapter 12 (Portfolio Manager) end to end — 12.2 on the three types of service, 12.4 on registration, 12.5 on responsibilities, 12.6 on costs and fees, 12.7 on the direct access facility and 12.8 on performance disclosure. The numbers are asked directly: the Rs 50 lakh client minimum, the Rs 5 crore net worth, the 30% associate cap, the five-year principal officer experience. Expect at least one arithmetic question on hurdle rate and high water mark, and a definition question separating discretionary from non-discretionary from advisory.

• Rs 50 lakh is the minimum the manager may accept from a client; Rs 5 crore is the manager's own net worth. Both figures appear in the options of the same question.
• Non-discretionary is not advisory. In non-discretionary the client decides and the manager executes; in advisory the client decides and executes, and the advice is non-binding.
• A discretionary manager must manage each client individually and independently, in a manner that does not partake of the character of a mutual fund. That sentence is the regulatory line between PMS and a pooled scheme.
• The high water mark is a level; the hurdle rate is a rate. A year can clear the hurdle and still pay nothing because the value sits below the previous high — as year 2 to 3 above shows.
• No catch-up means the share is computed only on the excess over the hurdle. Catch-up computes it from the first rupee of gain once the hurdle is crossed. The difference is real money.
• The 30% associate limit is a cap with consent, not a prohibition — a one-time written consent from the client is required.
• A portfolio manager cannot borrow on the client's behalf and cannot buy below-investment-grade securities. Neither restriction applies to every fund structure, so do not generalise them.