Discretionary Portfolio Management Services (PMS) – Meaning, Benefits & Risks

Discretionary PMS (portfolio management services) are specific investment services where professional managers are provided full authority to make investment decisions on your behalf. Let us learn more about it below. 

What is Discretionary PMS?

So, what is discretionary PMS? It is an investment service, where the professional manager gets the total authority to make investment decisions, such as selling, buying or timing trades on your behalf. So, in this case, discretionary portfolio management services do not require your official approval for each and every transaction. 

However, the manager has to abide by the strategy that has been agreed upon with you based on your preferences and risk profile. This is a more hands-off approach to investments which may suit you if you do not have the market expertise or time to manage your portfolio. 

How Does Discretionary PMS Work?

Now that you know about the discretionary PMS meaning, it’s time to understand how it actually works. In this case, the following steps are usually seen: 

• You first define your financial objectives, risk tolerance, and preferred investment duration 
• The manager will then choose a pre-defined model portfolio for you or build a strategy syncing with your risk profile and needs
• He/she will then independently manage the portfolio, conducting trades and rebalancing the portfolio as per the strategy
• You will get regular reports on the status of the portfolio and performance 

The entire concept revolves around delegated authority to the manager who does the research and makes investment decisions on your behalf. Securities are also held in your name in a dedicated demat account, which gives you direct individual ownership. The charges usually include a 1-3% fixed management charge and sometimes performance or profit sharing fees. 

Types of Portfolio Management Services

It’s not just about choosing discretionary PMS in India. There are many other kinds of portfolio management services that you can also consider. Some of them include: 

• Non-Discretionary PMS- In this system, the manager of the portfolio will only recommend specific investments. You have to approve every single transaction before it is executed. 
• Advisory PMS- Your manager will give you just research and advice. However, you will hold the full responsibility of independently implementing market trades. 

Based on the asset class and strategy, there are other types of PMS including the following: 

• Active PMS- For Active PMS goal is beating specific market benchmarks with frequent trades and intensive research 
• Passive PMS- The goal of Passive PMS is to track and mirror a market index with lower turnover and costs 
• Equity PMS- More focus on stocks, mostly divided across mid-cap, large-cap, thematic, and small-cap categories 
• Debt PMS- More inclined towards fixed-income securities like bonds
• Hybrid PMS- A combination of debt and equity in the portfolio 
• Multi-Asset PMS- Diversification of the portfolio across multiple asset classes, including debt, equity, and commodities 

Read more: Active vs Passive Portfolio Management

Discretionary PMS vs Non-Discretionary PMS 

Let us now come to the discretionary vs non-discretionary PMS debate. The key differences between these two types are highlighted in the table below. 

Benefits of Discretionary Portfolio Management Services

Some of the key advantages of discretionary portfolio management services include the following:

• Active Management- Access to professional expertise and active management based on extensive research. Managers can also capitalize on market opportunities better and adjust to market volatility swiftly. 
• Personalization- The portfolio is customized based on your goals, risk appetite, and even sectoral preferences at times.
• Quicker Execution- There is instant execution of trades and investment strategies without losing out on opportunities or taking corrective actions quickly. 
• Overall Convenience- You do not have to monitor your portfolio on a day-to-day basis and make decisions. 
• Objective Approach & Discipline- This system lowers the instances of biased, emotional, or even impulsive investments made by the client. 
• Comprehensive Reporting & Full Transparency- You will receive regular and detailed reports (audited) of your portfolio and overall metrics. 

Risks of Discretionary PMS

Some risks of discretionary PMS include the following: 

• Losing Direct Control and Managerial Risks- You delegate the decision-making authority to the manager in this case. Hence, you lose direct control over trades, even if you do not always agree with the strategy. The performance also depends heavily on the manager’s expertise and judgment, with risks arising from his/her biases or improper execution. 
• Higher Costs- The charges for discretionary PMS can be considerable, inclusive of management fees, entry/exit loads, and even performance-linked fees or profit sharing. 
• Concentration & Market Risks- The portfolio may be more concentrated towards particular stocks or sectors, thereby expanding losses in volatile scenarios. Your portfolio is also vulnerable to market risks at all times, including sudden economic shifts and other geopolitical events. 
• Risks of Liquidity- There are investments often made in assets with lower liquidity (such as small-cap stocks, for example), which may be hard to exit during volatile market conditions. 
• Conflict of Interest- There always remains even a 0.1% risk of the portfolio manager not always functioning in your best interests. 

Suitability of Discretionary PMS

So, does discretionary PMS suit you? Here are some aspects worth noting before you make a decision. 

• It is better suited for HNIs (high-net-worth individuals) who have a minimum corpus (sizable amount) to invest and want hands-off and professional portfolio management. 
• Busy investors and those without market expertise who believe in the reputation and expertise of managers may consider this option. 
• It is also suitable only for those who have limited time or interest to track market movements on a daily basis. 
• If you want quick action to be taken in volatile markets or even in case of spotting market opportunities to aggressively pursue growth, this system suits you. 

SEBI Regulations Governing Discretionary PMS

There are several SEBI discretionary PMS guidelines that are worth noting at your end. Some of them include the following: 

• SEBI mandates a minimum investment of ₹50 lakh per client for PMS as per its SEBI (Portfolio Managers) Regulations, 2020 regulations. 
• Portfolio managers should also maintain ₹5 crore as their minimum net worth. 
• Discretionary PMS is not allowed to make investments in unlisted securities, while investments in related associates/parties are limited to 30% of the client’s AUM (assets under management). 
• It is not allowed to borrow securities or funds on the client’s behalf, while leverage is not allowed for equity portfolios, even though hedging-related derivatives are allowed. 
• Portfolio managers should compulsorily register with SEBI while an independent custodian should hold the assets of the client. 
• Periodic reports are required every three months for clients at least, while a dedicated compliance officer is also mandatory. 
• Providers should offer a disclosure document to clients before signing the agreement, with the agreed-upon fees mentioned in the same. 
• Performance calculations should be done with the TWRR (Time-Weighted Rate of Return) system, while lock-ins are allowed, though exit fees are charged.

Fees and Charges in Discretionary PMS

Discretionary PMS usually involves fixed management fees of about 1-3% per annum, along with performance-based (profit sharing) fees which may be around 10-20% of the profits over the hurdle rate. There may also be transaction-linked costs along with brokerage commissions, demat/custodian fees, audit fees, and exit loads for early withdrawals. Performance fees are usually charged when the value of the portfolio crosses the highest value that was achieved earlier. This makes sure that fees are not paid upon the previous losses being recovered. 

There may be the entry load of up to 3% of the initial investment as a one-time fee. Exit loads of 1-3% for exits within 1-3 years may also apply. Trading and brokerage charges up to 0.5% per transaction may be charged, while the custodian and operating costs may be 0.25-0.50% for holding securities and auditing. GST is also payable on all the expenditure and fees. 

How to Choose the Right Discretionary PMS Provider

Here’s how you can choose the right discretionary PMS provider: 

• Check whether the PMS provider is focusing on value, growth, momentum, or even a blended strategy. Make sure that the approach syncs with your risk profile and appetite (high turnover, concentrated portfolios, etc.).
• Analyze the historical performance and experience of managers throughout multiple market cycles. Don’t just look at the recent returns. 
• Ensure that the provider offers regular and clear reporting on the portfolio and performance changes. This should ideally be more frequent than the mandatory half-yearly or quarterly basis. 
• Evaluate the PMS costs, including the management and performance-linked fees. 
• Confirm that the PMS has registration with the SEBI (Securities and Exchange Board of India). 
• Ask about the risk management strategies of the provider and how the manager handles market volatility and potential drawdowns. 
• Check the reputation of the provider along with the market longevity, exit loads, minimum thresholds for investment, and overall accessibility. 

Conclusion

Now that you have an idea of discretionary PMS and its key aspects, it is time to make your decision. If you fit the bill in terms of the minimum investment criteria and the provider matches up to your evaluation checklist, you can consider going ahead. However, it has to match your financial goals, circumstances, preferences, and temperament.