Risks of Investing in Portfolio Management Services

Portfolio management services (PMS) are beneficial to a wide range of investors seeking personalised, expert wealth management. There are risks associated with portfolio management services that investors should be aware of. Let us examine them in more detail below. 

Understanding Portfolio Management Services 

Portfolio Management Services (PMS) provides customised, professional investment management solutions for individuals, primarily HNIs (high-net-worth individuals), with dedicated managers managing and building portfolios of bonds, stocks, funds, and other assets for clients. It not only ensures direct ownership but also offers greater flexibility and personalised strategies for wealth creation and management aligned with your goals. 

The core aim is to generate risk-optimised and adjusted returns with active management and detailed research. The minimum investment threshold for PMS is around ₹50 lakhs. Portfolios are customised to your financial objectives, risk tolerance, and investment approach, while you also directly own the underlying securities in your demat account, unlike units of pooled funds. There is also real-time tracking and detailed, transparent reporting. Optimising portfolio diversification for maximum returns is another advantage of PMS. 

Key Risks of Investing in Portfolio Management Services

Here are the portfolio management services risks that you should watch out for.

1. Market Risk

There is a risk that investment values will decline or erode due to several factors, including market movements, geopolitical events, economic cycles, and poor or underperforming portfolio management strategies.

2. Risk of Underperformance

You have to contend with the risk that the portfolio may not achieve its performance goals or underperform the benchmark index or other such funds.

3. Fee Structure Risk

Another aspect of PMS is the management fees and performance-based charges it entails. This may often be on the higher side, thereby eating into your returns. 

4. Lack of Liquidity

Another risk you may face is insufficient liquidity when selling assets like private equity or small-cap stocks. This may be hard to do during market downturns, thereby affecting market prices.

5. Concentration Risk

These risks arise whenever a portfolio is heavily concentrated in a few stocks, securities, or asset types. This may make the investments more vulnerable to market fluctuations and other adverse scenarios. 

6. Managerial (Fund Manager) Risk

An inherent disadvantage of PMS is that it is highly manager-centric. The fund manager's investment decisions directly affect performance and investment risks. Sometimes, poor strategic execution, errors, and biases may lead to unforeseen and unwarranted outcomes.

7. Account Size and Diversification Risk

Making a sizable initial investment (with a high minimum amount) to enable wider portfolio diversification may be tough within the specific frameworks that govern how PMS operates. This may make the portfolio vulnerable to sudden and quick events.

8. Regulatory Changes

There is always the possibility of losses arising from new Government or tax laws, policy changes, and other new regulatory reforms or updates. These may impact not only particular types of assets or investments, but the whole market or specific sectors.

9. Taxation Considerations

There may be a sizable impact of capital gains tax and other implications on your final net (post-tax) returns. PMS may not always make your portfolio more tax-efficient.

10. Opportunity Cost

One drawback of portfolio management is the potential for an opportunity cost. You may miss out on alternative investment options that were not pursued immediately due to the PMS's specific strategies.

11. Inadequate Due Diligence

There is always a risk arising from insufficient due diligence or research on the manager and PMS provider, the investment strategy, and the underlying investment options or assets before committing funds. 

Mitigating Risks in PMS Investments

Here are some of the strategies you can follow in mitigating PMS investment risks.

Due Diligence

Make sure you do thorough due diligence to carefully mitigate risks. The goal is to make informed decisions after evaluating the nature of investments, the strategy to be followed, the fund manager’s reputation, and the overall credibility and profile of the PMS provider. 

Check the provider's track record across multiple market cycles beforehand. Verify the compliance history, legal structure, and manager’s internal controls to avoid fraud or any future mismanagement. Other red flags include opaque and vague reporting mechanisms, excessively large management charges, and high manager turnover.

Investment Objectives

Always ensure the PMS's investment strategy aligns with your long-term goals and risk appetite. This is vital for bypassing emotional decisions. Clearly define the goal-whether you want capital appreciation or preservation, income generation and dividends, or steady long-term growth. 

There should be a separate and liquid fund for emergencies, while the risk profile should be clearly conveyed while framing the investment strategy, i.e. sectoral, aggressive, or conservative. 

Diversification

Spread your investments across multiple asset classes and sectors, including equity, bonds, debt, real estate, and more. Avoid over-reliance on any one sector or geographical region. Choose assets not moving in tandem.

This ensures that whenever any one asset underperforms, the others maintain proper stability. 

Regular Monitoring

Consistent monitoring of your portfolio will help you identify potential issues early to take timely corrective steps. Compare portfolio performance against relevant benchmarks without focusing solely on absolute return. Also, periodic portfolio adjustments or rebalancing is necessary to maintain the original asset allocation targets. Always relook at the portfolio in the event of sudden, severe market events as well. 

Cost Analysis

Analyse the fee structure, including management and performance-based fees, along with transaction/trading costs if any, expense ratios, and turnover impact.

Understand the tax implications, then prepare your final returns and check whether they meet your desired targets. 

Liquidity Planning

Being unable to sell your assets when required without incurring losses is classified as liquidity risk. You should maintain a balanced portfolio with highly liquid and less liquid assets. 

Understand the redemption charges and penalties, exit loads, lock-in periods, and other exit terms of the PMS carefully beforehand. 

Review of Regulatory Compliance

Ensure your PMS provider operates in accordance with the relevant regulatory framework. In India, this means registering with the Securities and Exchange Board of India (SEBI) and adhering to the mandatory initial investment guidelines and other rules. The provider should also have detailed, regular reporting mechanisms for transactions and portfolio holdings. 

Unique PMS Considerations

There are multiple PMS concentrations worth keeping in mind at your end as well. These include:

• Higher Concentration:

Unlike mutual funds, which are already required to be suitably diversified across multiple stocks, PMS portfolios are usually more focused. 

They may have a limited count of focus assets or stocks to ensure higher returns at times. Hence, if a particular sector or stock performs poorly, the overall portfolio may be considerably affected 

• Manager Dependence:

The PMS's performance depends heavily on the manager's experience, knowledge, and skills. The success or failure of the strategy and investment depends directly on the manager’s ability to navigate multiple market cycles. 

• Costs:

PMS usually comes with higher costs than mutual funds. Annual management charges may range from 1% to 3% of AUM (assets under management). Some providers may charge performance-based fees of 10-20% of profits above the fixed threshold. 

There may also be exit loads of 1-3% for early withdrawals, as well as custodian and brokerage fees. Also, each time the manager sells a stock, it may trigger taxable events for investors, making it less tax-efficient than mutual funds at times.