PMS Fee Structures Explained: Fixed, Profit-Sharing, Hybrid

 Key Takeaways:

• A portfolio management scheme charges through a fixed fee, a profit-sharing fee, or a hybrid of the two, and each behaves differently depending on performance.
• Fixed costs remain the same whether there is a good year or a bad year, whereas profit sharing costs behave the opposite way.

• The total cost will encompass a lot more than just the mentioned fees: brokerage charges, custodian fees, GST, and exit loads will also form part of the total cost

   

   

PMS Fee Structures Explained: Fixed, Profit-Sharing and Hybrid Models

You've narrowed down a portfolio management scheme you like. The strategy fits your goals, the manager's track record looks solid, and then you reach the fee page. Suddenly there are three pricing models, and none of them are explained in plain language.

This is where investors either overpay without realising it, or walk away from a portfolio management scheme that would have suited their investment strategies well. This blog breaks down the three fee structures you'll encounter and how to match one to your own investment strategies.

What Is a Portfolio Management Scheme?

A portfolio management scheme is a SEBI-regulated service where a professional manager builds and runs a customized portfolio of stocks on your behalf, inside your own demat account. Unlike mutual funds, you own the underlying securities directly, and the fee is negotiated between you and the manager rather than set by a regulator.

Since there is no universal standard rate within the business, knowing about the cost structure of a portfolio management program is important. It will distinguish between investment plans that earn returns even after deducting costs and those that lose money due to costs.

Fixed Fee Model

The simplest of the three. You pay a set percentage of assets under management every year, typically 1% to 3%, charged quarterly, regardless of performance.

In case your manager performs very well during the year, then you benefit entirely from his gains. In the event of poor or mediocre performance, you pay the same fee regardless. It’s a risk-reward proposition  predictability on your side, but no margin for error from the marketsIt’s an arrangement that will appeal to investors who seek clarity in the expenses they have to pay and are willing to accept the fact that the manager will get paid regardless of whether he beats the market or not.

Profit-Sharing Fee Model

Sometimes known as a performance-only fee, it costs you very little or anything at all until the manager achieves a predetermined hurdle rate of 8% to 10%. Above the hurdle rate, the manager earns 10% to 20% of the profits.In a weak year, you pay very little. In a strong year, the fee can exceed what a fixed structure would have cost. This ties the manager's earnings directly to your results, which is the appeal, though it also means costs swing year to year.

It is safe to assume that most of the managers use a high water mark, which means that you will pay performance fees for the new profits and not for those profits that have recovered the losses made earlier. Ensure that this is included in the contract before you invest in a portfolio management system based on profit sharing arrangement.

Hybrid Fee Model

In a hybrid fee system, there is a lower fee that is fixed and then an additional performance fee which is usually lower than the normal one, say 1% to 1.5% fee fixed plus 10% of gains after hurdle rate.

This ensures that costs are shared fairly. The manager gets something even in a flat year but does have an incentive to do well. In many cases where investors weigh their investment options, the hybrid becomes the better option, being the middle ground between a purely fixed fee and a purely performance fee.

to Consider Before You Choose

The headline fee percentage isn't the whole picture:

• Total cost, not just the management fee. Operating expenses, broker's charges, custodian’s charges, cost of auditing, and GST all sum up. SEBI has currently set a ceiling on operating expenses, without including brokers' charge, to 0.50% p.a. of average daily assets under management.

• Exit load. Many providers apply a declining exit load, often around 3% in year one, 2% in year two, and 1% in year three, nil after that. Exiting early can cost more than the fee itself.

• No upfront fees. SEBI rules don't permit portfolio managers to charge upfront fees on a portfolio management scheme, so any structure asking for one is worth questioning.

• Illustrative, not guaranteed. Whatever numbers a manager provides, even if they are part of the break-even analysis for a certain pricing strategy, are just projections. It all depends on the market and cannot be guaranteed.

How mastertrust Helps

After choosing an appropriate fee structure based on the investor's strategy, there are costs related to execution. The simplicity of this is handled by mastertrust. The fees applicable on stock, F&O & commodity transactions will be ₹20 per order.

If you're running a portfolio management scheme alongside your own direct holdings, this pricing keeps your overall cost base lean. Master portfolio services Ltd., a SEBI registered PMS offers personalized, risk-managed investment strategies. 

Final Thoughts

There can never be an absolutely right structure for the charges for the portfolio management service. The fixed charge provides for certain payment terms, whereas the profit sharing charge makes for performance-based cost. The combined charge is somewhere in the middle of the two extremes. Look at the entire prospectus, see that there is a high watermark clause, add up all the costs involved, and select whichever suits your investment tenure.

Frequently Asked Questions (FAQs):

Q1. What's the minimum investment for a portfolio management scheme?

SEBI mandates a minimum investment of ₹50 lakh for any portfolio management scheme, across all fee structures.

Q2. Can a portfolio management scheme charge an upfront fee?

No. SEBI rules don't permit upfront fees, regardless of whether the scheme uses a fixed, profit-sharing, or hybrid structure.

Q3. Which is cheaper, fixed or profit-sharing?

It depends on performance. Fixed fees cost more in a weak year; profit-sharing fees can cost more in a strong one. There's no answer independent of how the portfolio actually performs.

Q4. What is a high-water mark?

The rule guarantees that the payment of performance fee will be based on new profits and not profits that have recouped losses from a previous drawdown. Look out for this rule in any profit-sharing or hybrid portfolio management arrangement.

Q5. Are returns guaranteed under any fee structure?

No. All portfolio management scheme returns are market-linked, and any projections shown are illustrative, never a guarantee of future performance.