Understanding The Working Of PMS

The thoughts of individuals who are investing in markets is that when one is a rocket scientist he or she needs to have training for that, whether one is a teacher or a physicist- all require training. But equity investing is the simplest thing which people think to do with an “I can manage it myself” attitude; although this is a very complex world in which you are making decisions and you need to know what to filter, what really to focus on, what not to focus on and then make that decision of whether you want to be invested in a particular name or not. For that, having specialized knowledge is quite important. Also, there are specialists whose day job is to understand businesses, understand management, understand the environment and then make that call. Given all of that, it is only good that you entrust such specialists with the responsibility of making those decisions for you.....especially if you don’t have the time to research and understand businesses of your own. 

Assuming that you are going for discretionary service, you have a demat account, you give your POA. After this, what is the rate of churn? What is the frequency of buys and sells? How is the portfolio really constructed?

It depends upon the portfolio manager. Normally, it is expected that when one is going for a PMS, you will not be churning too much. Market norm is churning probably once a year with a concentrated portfolio and long term holding.

The idea of PMS is basically that one is looking for those kinds of stocks where we have to give some time. The story will play out over time. So, one needs to stay with it. It isn’t possible that today I will buy and after two to six months will sell. The gain depends upon what is the philosophy of the fund manager, what objective has the investor given at the time of discussing with the portfolio manager and what the investor is looking for. One can have a PMS with a very aggressive churn rate also provided somebody says he or she wants a PMS where they need a kind of hedge fund every day. So, it depends upon the time horizon that the investor specifies while taking a call on which fund the fund manager is interested in getting in. To shorten, the fund manager has to understand the investor’s philosophy and match that with his philosophy. 

How much return is expected from a PMS scheme?

PMS can deliver 20 to 25 percent return over the long term. When the markets are down by supposedly 5 percent a year, expecting a positive 15 percent return may not be the right expectation. In that year, one may see a downside because markets are down but it will evolve itself if the economy keeps growing. Warren Buffet made an interesting statement regarding this; in fact his guru, Benjamin Graham used to say that markets in the short term are voting machines and in the long term they are weighing machines. This implies that in the short term we will have volatility drives in the markets whereas in the long term we will have fundamental drives in the markets. According to this philosophy, if you have a 15 percent or a 20 percent down year, there will be other years which because of earnings growth will be much better than that. In short, an alpha over that 15 percent market growth rate over a 5 to 10 year period is something that investors should expect from equities and in PMS in particular.

What should be the composition of the portfolios?

It might be said that it is better to invest in small and mid-cap companies where there is a trigger point or a catalyst for the stock to perform. Catalyst for a stock can be just a capacity expansion, promoter change; it could be market exploding, change in technology to name a few. Promoter background is an important criterion that plays its role here. It is recommended to bank on small promoters who may or may not have a track record in the past, so we will have to bank on their capability and see if what we are expecting they will be able to deliver. It is because if they deliver, then only the stock price will perform. So, there is bound to be a mistake here because the portfolio manager is taking a judgmental call on the person’s capability.

It is important to identify mispricing. Essentially, in concentrated portfolios, the portfolio manager needs to not just worry about the upside but the downside as well. Downsides can be prevented on a permanent basis if the portfolio manager does two things- get the right fundamentals and buy them at reasonable valuations. Also, try and understand why the stock is cheap and what will be the catalyst for that cheapness to go away. If this cycle can be completed by the portfolio manager, it is sure that the capital won’t be lost permanently. Lower the losses, greater the chances one makes money eventually. So, the objective for the portfolio manager is to ensure not to lose money first and then identify triggers for values unlocking over a period of time.