Operational aspects of PMS

The operational chapter is where the exam separates people who have read about PMS from people who could actually onboard a client tomorrow. It covers documents, accounts, fees, reporting and your own registration as a distributor. Most of the numbers here come from SEBI's 2020 guidelines for portfolio managers, so learn them as rules, not estimates.

Onboarding: documents before money

The sequence matters. First, KYC through a KYC registration agency or CKYC, with PAN, address proof, FATCA declaration and nomination. Second, risk profiling: the manager must assess the client's risk appetite and record that the chosen investment approach is suitable. Third, the disclosure document, whose contents are prescribed in the Regulations. It describes the manager's business, services, fee structure, risks, disciplinary history, related-party dealings, audited financials and performance of each investment approach. It is certified by an independent chartered accountant, filed with SEBI, kept updated, and must be given to the client before the agreement is signed.

Fourth, the client agreement, with the minimum contents prescribed by the Regulations: the services offered, the investment approach and its restrictions, the quantum and manner of fees, the tenure, risk factors, the manner of settlement, liability of the manager, termination terms, and dispute resolution. A fee illustration is annexed showing how fees would be charged over several years in rising, flat and falling scenarios. Fifth, the client opens a demat account in her own name and gives the manager a limited power of attorney to operate it. Client funds are kept in a bank account separate from the manager's own money; the Regulations allow a common client bank account with client-level ledgers, but securities are always segregated client by client.

Fees and charges

Fees are set by agreement, but SEBI has fenced them:

• Fixed management fee: a percentage of assets, usually computed on average daily value and charged quarterly.
• Performance fee (profit sharing): a percentage of gains, charged only on gains above the high-water mark, which is the highest value of the portfolio at the end of any previous fee period on which a performance fee was charged. A hurdle rate may be added so that the fee applies only to returns above, say, 10% a year. SEBI requires the high-water mark principle whenever a performance fee is charged.
• No upfront fee of any kind, directly or indirectly.
• Exit load on withdrawal: at most 3% of the amount withdrawn in the first year, 2% in the second, 1% in the third, and nil after three years from the date of investment.
• Operating expenses other than brokerage (custody, audit, demat, RTA): at most 0.50% a year of the client's average daily assets. Brokerage is charged at actuals.

Without the high-water mark the manager would have charged again in year 3 on the whole recovery from ₹1.10 crore, earning a fee for merely getting the client back to where she was. How the hurdle compounds across years varies between agreements, so read the fee illustration.

Exit load example: a client who withdraws ₹60 lakh eighteen months after investing can be charged at most 2%, that is ₹1.2 lakh; the same withdrawal after three years carries no exit load.

Reporting, audit and exit

The client receives a report at least once every quarter (and whenever she asks) showing the composition and value of the portfolio, every transaction in the period, income received, expenses and fees charged, and the performance of the account against the benchmark, with the risk disclosures relevant to the approach. The portfolio manager's books relating to PMS are audited every year, and the client is entitled to an annual audited statement of her account and may appoint her own chartered accountant to audit it at her cost. Managers also file monthly data with SEBI and publish investment approach performance through the Association of Portfolio Managers in India (APMI).

Either side may terminate the agreement on the notice provided in it. On termination the manager returns the portfolio as securities transferred to the client's demat or as cash after sale, as the client chooses, net of fees and any applicable exit load. Complaints go to the manager's compliance officer, then to SEBI's SCORES platform and the ODR portal.

Distributors: registration, code and conduct

A person who distributes PMS must hold a valid NISM-Series-XXI-A certificate and be registered with APMI, which issues a registration number; the portfolio manager then empanels the distributor and allots a distributor code under which clients are tagged. Commission is paid by the manager out of its own fees, only on a trail basis, never upfront, and the amount paid must be disclosed to the client. Every manager must also offer direct onboarding: a client may sign up without a distributor and pay no distribution-related charge, and this option must be shown on the manager's website and in the disclosure document. The distributor may not collect fees from the client, accept cash, guarantee returns, or misrepresent the approach.

If a question describes a process, ask yourself whether the client could have signed the agreement with full knowledge. Disclosure document, fee illustration, risk profile, then agreement, then money; that order resolves most operational questions.