In the month of May – 2022, we have seen a lot of hue and cry against the AMFI (Association of Mutual Funds in India) campaign “Mutual Funds Sahi hai”. It all started behind the curtains in
Feb '2022, when Axis AMC started a suo moto internal investigation. AMC hired two reputed external advisors - Alvarez and Marsal and AZB & Partners to look into the conduct of the two fund managers in the front running investigation. Both were first suspended and then one by one both have been terminated by Axis AMC. Since then, the Income Tax department has also raided and found income disclosed in tax returns and the size of investments were disproportionate.

Some people on social media have strongly protested the argument and questioned whether Mutual Fund Sahi hai. Most of these people have a conflict with Mutual Funds, they either want to promote their PMS, Smallcase or Direct Stock Advisory (RIA/RA).

Similar was the negative buzz created by these influencers (having conflict of interest) when some of the Mutual Funds applied in the IPO of new age companies.

Yes, Mutual Fund Sahi hai and this blog is all about it.

MF Vs. PMS + Smallcase

1. Taxation: In my opinion this is one of the biggest differentiators between Mutual Funds and other investment options.

Stocks in Mutual Funds are held in a trust and any buy-sell of securities by fund manager for rebalancing or entry-exit purpose, doesn’t trigger taxation for the unitholder (investor in MF) and mutual funds have pass through status and any income (capital gain / interest / dividend) is non-taxable as well.

Taxation for investors in Mutual Funds will only get triggered on sale of units (either in the secondary market or on repurchase by the AMC).

On the contrary, stocks in PMS or those bought through a small case are held in the name of the investors, so any income (capital gains, interest, dividend) is taxed immediately. Interest and dividends are taxed at marginal rates.

Mutual Funds, in the long term, have the ability to defer taxes for decades. And this deferment helps in compounding.

It doesn’t make any sense to go for Fixed Income PMS. Interest will be taxed as per slab rate and MFs have the advantage of providing for indexation and lower tax rate.

2) Standardization: Mutual Funds offer standardized solutions.

Especially after SEBI regulation around "Categorization and Rationalization of Mutual Fund Schemes'' announced in October 2017. It has become easier for the investors to clearly distinguish the schemes in terms of asset allocation and investment strategy. Therefore, investors are able to evaluate the different options before making an informed decision.

For example, in a large cap scheme, 80% of the portfolio is in large cap stocks (top 100 stocks as per total market capitalization).

There is no standardization in PMS. The Portfolio Manager can tilt the portfolio as he wants. A Multicap of PMS is more like the Mid or Small cap of a Mutual Fund.

3) Regulatory Risk Management: By regulatory design Mutual Funds are far superior in risk management
A fund manager cannot take more than 10% exposure (except in index funds), in one single security. In PMS no such restrictions are there, fund managers can take concentrated risk to any extent. In Smallcase, only two securities are needed to construct the portfolio. 

In PMS, everything can be negotiated, be it expense Ratio, profit sharing or no profit sharing, hurdle rate for profit sharing, exit load period, etc. Retail investors do not carry the bargaining power to negotiate these matters due to their limited investment size.

4) The terms remain same for everyone in Mutual fund structure

Costing and Terms Discrimination and Negotiations: In Mutual Funds, there are capping on expense ratio and beyond which no scheme can charge, as the AUM goes up, the ceiling comes down. Investor friendly, right. 

In PMS, there is no capping on expense ratio.

It’s not a one on one contract between the investor and AMC. There are no negotiations, the expense and term are applicable to all, be it institutional investor or be it retail investor.

In PMS, everything can be negotiated, be it Expense Ratio, Profit sharing or no profit sharing, hurdle rate for profit sharing, exit load period, etc. So, in a way, investors with bigger wallets can negotiate for more favorable terms.

5) Disclosures & Data for Analysis: In Mutual Fund, the disclosures are far more transparent than PMS.

Here, I am not just talking about investors, but for the public at large.
In a Mutual Fund, NAV is disclosed on a daily basis. It is the NAV at which all the buy and sell transactions happen.

In PMS, investors know everything about the transactions executed, as securities are bought in the name of the investor. But they cannot analyze the historical performance or risk metrics of the PMS.

Even the regulator has instructed the portfolio managers to give a disclaimer in all marketing brochures that performance is not verified by SEBI. (13 (vi)). 

SEBI also had concerns about discrepancies in performance reported in marketing material and SEBI website (13 (1v)). 

6) Benchmarking: AMFI has published the indices (on instruction from SEBI) to be used by AMCs for different categories as benchmarks.

Although AMC can choose an additional benchmark, the primary benchmark is decided by AMFI.

Benchmarking in PMS is a joke. Mid and Small cap PMS compare their performance with large cap frontline indices. Appropriate benchmarking is something SEBI should look into.

7) Ease of Investment & Withdrawal: With mutual funds, you can start investing as low as with INR 100.
You can opt for systematic solutions like SIP, STP and SWP.

In PMS, it’s very complicated. You cannot start with even a dime less than INR 50 Lakhs. Even for withdrawals, you cannot partially withdraw such an amount that the market value of the balance portfolio is less than INR 50 Lakhs. For example, If the current market value of a portfolio is 62 Lakhs, then investor can withdraw any amount upto 12 Lakhs or withdraw the full 62 Lakhs. The investor cannot withdraw 15 Lakhs, as the market value of the remaining portfolio will be less than the regulatory threshold of 50 Lakhs.

Similarly, minimum top up required for clients onboarded before January 21st, 2020 should be such that the portfolio becomes equal to or greater than INR 50 Lakhs.

(Before 21st Jan’2020, the minimum investment amount was INR 25 Lakhs, now it is INR 50 Lakhs)

Loss Absorbing: Although AMCs have set wrong examples, they have many times absorbed the losses of wrong calls. Whereas, this is not even remotely possible in PMS.

Random Thoughts:

1. Always look at the performance and actions, holistically. Mistakes and losses are bound to happen. For example, many AMCs applied for the IPO of new age companies. Look at the big picture.

2. Stay away from PMS’s which take concentrated positions in stocks with low free float. Whether the stocks are micro cap or large cap quality stocks, doesn’t matter. For the last two years, we have observed this happening in a very famous large cap PMS in high PE stocks. In case of redemption pressure, price will be in pressure, which can trigger more redemptions. These things never end well.

3. Front running will never stop If few employees of AMC are accused of front running, it doesn’t mean the AMC or the industry is unethical and doesn’t justify panic redemptions. It can be anyone who is unethical and with insider information, be it a close associate from promoter group or a TV anchor or someone in the dealer team of institutional investors.

Nothing in this article should be constructed as investment advice; readers are advised to consult their financial advisors before making any investment decisions.