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Commentary

More Pooling Problems for PMS Providers

Hindustan Times: ‘No pooling’ norm to hit PMS hard:

As per industry estimates, close to Rs 10,000 crore is housed in portfolio management schemes, of which more than three-fourths is operated in the pool format. SEBI has given a time frame of six months for PMS houses to fall in line with changed regulations.

“They (portfolio managers) would be required to keep assets of each client separately and not in a pooled manner,” SEBI said in a release on Tuesday.

Over past few years, brokerages and PMS players had been pushing pool PMS to retail investors, eager for a slice of action in the booming stock market. As per the agreement signed, customers who had similar investment preferences could join in, without even having to open a demat account.

Pool account, in spirit, operate on the lines of asset management companies. Brokerages open ‘pool PMS’ as a common account, under one head. Fund managers pool-in investments received from clients and start investing on behalf of the whole group. The purchased bouquet of stocks are allotted pro-rata to the clients’ portfolio as per their investments into the PMS.

This ensured minimal documentation procedures for the investors and easier operations for the PMS provider. With SEBI clamping down on these pool PMS, investors who have been availing of this facility will have to open separate demat accounts. Each of these accounts will contain shares purchased specifically for the investor by the fund manager.

PMS managers also say that managing individual accounts and execute trades separately will lead to enormous strain on the brokerages. Under pool PMS, brokerages could execute trades for hundreds of clients at one go. Now with new guidelines on, brokerages will be forced to execute trades for each and every client separately. Brokerages will be forced to pass on additional transaction costs (by way of more trades and more dealers involved) to customers, they warn.

“If SEBI had intended to apply brakes on pool PMS, it would have done well by raising the threshold limit,” said a PMS fund manager. What he means is SEBI could have put a limit (say Rs 25 lakh ) over which no pool PMS could be permitted.

Broking houses usually find it easier (and economical) to manage investors with lower absolute investments in the pool format. One needs at least Rs 5 lakh to invest in PMS, as per current regulations. However, according to PMS fund managers, most brokerages will find non-pool PMSs an unviable proposition as broker’s commission on a Rs 5-6 lakh PMS account is less than Rs 1,000 every month.

Such bull, no?

If 1 Pool account produces commissions of Rs. 10,000 per month, and is split into 10 accounts for which they get 1,000 per month each, what’s the difference? Of course such math is just for show, the real problem is that they can’t hide their prop account losses in non-pooled accounts. (Read: Stopping the PMS Abuse)

The technology problem is also ridiculous to mention – they no doubt have software to automatically assign trades to accounts, and divide trades into appropriate accounts. They do this anyhow, because at some point trades do get assigned to accounts, so what’s the big deal in doing that at the time the trade is taken? That’s just an excuse.

Another issue, I think is the size of trades. Let us assume 10 accounts of Rs. 5 lakhs each, giving you a 50 lakh pool. In that pool the brokerage can take all sorts of trades, including futures trades which can add up to 50 lakhs. PMS accounts are not allowed any leverage. (A norm that surely is flouted, but I have no proof) So for 50 lakhs you can only buy 50 lakhs worth of futures. Take an RPL contract. The futures contract size is Rs. 3.2 lakhs. For a 50 lakh pool, the brokerage could technically take up 15 futures contracts. But at each account level they can take only 1 (since the size of the account is 5 lakhs each) – so for 10 accounts, they can only take 10 trades. [Note: this is just illustrative]

Now obviously they would assign trades to accounts then too, right? What happens to the remaining 5 trades? Answer: if they are profitable, they go into the PMS providers pocket – only the profits of 10 trades are allocated to customers. If they are not profitable, the loss is divided into 10 contracts, and the five are stashed away as “squared off even”. Heads they win, Tails you lose.

With the removal of pooling, such blatant manipulation is disallowed. Which is also why some PMS providers are sulking.

Lastly, the creation of individual accounts for each account gives every user the ability to cross check trades – with the depository or the exchange. That is not something the PMS provider will like because it is a trail – and anything that was “hidden” earlier will come out in a surveillance operation by the exchange or courts.

But since they have six months, expect the maximum churn to happen from now till then. If you have a PMS account and suspect such activity, I’d say simply pull it out before this happens to you.

  • Pronto says:

    >You mention that pull out now and get in after six months. My point is why get in at all? Any time? Mutual Funds are nothing but formalised PMSes that are not only cheaper but also under SEBI’s nose with far more discloures and transperency. Why choose PMS at all when we have an option of mutual funds

  • Anonymous says:

    >Mr.Deepak,
    It is really very hard for anyone who is availing PMS services,not to totally agree with your analysis and advice.They have already started churning portfolios like never before.Do keep posting your ideas and thought on this issue.
    mukesh
    muzaffarpur

  • Deepak Shenoy says:

    >pronto: Actually what I mean is that if you suspect such activity you should get out, because there are some honest PMS providers out there, no doubt.

    But you’re right – why get back in if you see such activity? So I’ve edited the post accordingly. Thanks for the heads up.

    Anon: Thanks mate. I hope enough people read about this.

    There is a need for more transparent and honest PMS services. That, hopefully, will be the future.