Understanding PMS Fee Structures: Is 'Skin in the Game' Really in Your Interest?Understanding PMS Fee Structures: Is 'Skin in the Game' Really in Your Interest?

(This article is Part 5 of 6 in our PMS Guide for NRIs: The Nuts and Bolts series)

Understanding the fee structure is crucial because these costs directly impact your returns. PMS fees aren't as straightforward as a single percentage. They come in several forms, each designed to align the portfolio manager's interests with yours in different ways.

Management Fees are your portfolio manager's salary. These are annual charges, typically ranging from 1.5% to 3% of your portfolio value, charged quarterly and deducted directly from your account. Think of this as the cost of having a dedicated professional managing your money full-time.

The management fee covers research, portfolio construction, risk management, and all the operational overhead of running a professional investment management business. In this structure, when your portfolio value increases, the management fee (being a percentage) increases proportionally. When your portfolio value declines, the fee decreases accordingly. So while the percentage remains constant, the absolute fee amount moves in sync with your portfolio's performance.

Performance Fees are where things get interesting. Many PMS providers charge a percentage of profits generated above a certain hurdle rate. This could be 10-20% of profits above the benchmark (like Nifty 50) or above a fixed return threshold (like 8% per annum).

Here's a simple example: Your portfolio generates 15% returns in a year, while the Nifty delivers 10%. Your outperformance is 5%. If your PMS charges 20% performance fee on outperformance, you pay 20% of that excess return. So the manager keeps 20% of the outperformance and you keep 80% of the outperformance, plus the full benchmark return of 10%.

High Water Mark is your protection mechanism. If your portfolio loses money, the performance fee clock resets. The manager cannot charge performance fees until your portfolio value crosses the previous high. This ensures you don't pay performance fees on recovering your own losses.

For example, if your Rs 1 crore portfolio drops to Rs 90 lakhs and then recovers to Rs 95 lakhs, you don't pay performance fees on that Rs 5 lakh recovery. The manager only starts earning performance fees once your portfolio crosses Rs 1 crore again.

Other Costs to consider include bank charges in case of NRIs, brokerage charges (usually passed through at cost), custodian fees, and sometimes setup fees. 

Negotiating fees: While management fees are often standard, performance fee structures can sometimes be negotiated, especially for larger portfolios. Some investors prefer higher management fees with lower performance fees for more predictable costs. Others prefer the opposite – minimal management fees but higher performance fees, betting on the manager's ability to deliver superior returns.

Fixed Fee vs. Performance Fee: A Critical Analysis

The performance fees based structure is often considered better evidence of having "skin in the game" – the idea that the portfolio manager only get paid when you make money. While this sounds compelling, it requires more critical analysis before accepting at face value.

At Capitalmind, we use a fixed fee structure because we believe it's more aligned with investor interests over the long term. 

Let's understand impact of different fee structures on a starting portfolio of 1 Cr over a period of 6 years. 

• We will use Adaptive Momentum strategy, which has shown alternating periods of significant outperformance and underperformance relative to the benchmark. By using actual historical portfolio performance, we eliminate timing bias from our analysis. While one could raise hypothetical scenarios—such as "what if the first three years were underperforming years?"—these what-if questions are endless and speculative. For the integrity of this analysis, we focus on real, documented performance data rather than theoretical projections.
• The portfolio is offered to resident Indians at 1% p.a fixed fee. 
• We will compare this against the performance fee of 20% charged over a) hurdle rate of 8% b) benchmark return - both with high watermark. 
• For ease of calculation, the fixed fee is calculated on average of starting and ending portfolio value for a period. 

 

Financial Year-wise Performance and Fee Analysis:

Total Fees Paid Over 6 Years:

• Performance fee (8% hurdle): Rs 31.41 lakhs
• Performance fee (benchmark hurdle): Rs 22.33 lakhs
• Fixed fee (average method): Rs 11.76 lakhs

Final Portfolio Value (Net of Fees):

• Performance fee (8% hurdle): Rs 2.58 Cr 
• Performance fee (benchmark hurdle): Rs 2.68 Cr
• Fixed fee (average method): Rs 2.82 Cr

Key Insights:

1. Even with two exceptional years (2020-21 and 2023-24), the fixed fee model delivers the highest final value at Rs 2.82 Cr.
2. The 8% hurdle performance fee extracted Rs 9.64 lakhs in 2020-21 and Rs 13.78 lakhs in 2023-24 - together representing over 75% of total fees across 6 years.
3. The 8% hurdle and benchmark hurdle charged Rs 13 + lakhs in 2023-24 alone - more than over 6 years of fixed fees in a single year.
4. Fixed fees at Rs 11.76  lakhs total is dramatically lower than both performance fee structures (Rs 31.41 lakhs for 8% hurdle and Rs 22.33 lakhs for benchmark hurdle).
5. Fixed fee structure preserves approx 19 lakh more capital compared to the 8% hurdle performance fee, demonstrating the compounding impact of lower fees over time.

Calendar Year Analysis: Same Portfolio, Different Perspective

Let's examine the same portfolio using calendar year returns to see how fee structures perform across different time periods:

Calendar Year Performance and Fee Analysis:

Total Fees Paid Over 6 Years (Calendar):

• Performance fee (8% hurdle): Rs 32.64 lakhs
• Performance fee (benchmark hurdle): Rs 27 lakhs
• Fixed fee (average method): Rs 12.18 lakhs

Final Portfolio Value (Net of Fees) - Calendar Years:

• Performance fee (8% hurdle): Rs 3.15 Cr
• Performance fee (benchmark hurdle): Rs 3.25 Cr
• Fixed fee (average method): Rs 3.47 Cr 

Calendar Year Key Insights:

1. Across both financial year and calendar year analyses, fixed fees deliver the highest final portfolio value.
2. Performance fees hit hard in 2021 (Rs 13.67 lakhs for 8% hurdle) and 2023 (Rs 7.53 lakhs), demonstrating repeated front-loading across different measurement periods.
3. Fixed fees remain dramatically lower at Rs 12.18 lakhs total vs Rs 32.64 lakhs (8% hurdle) - a Rs 20+ lakhs difference.
4. Whether measured by financial year or calendar year, the fundamental flaw of performance fee front-loading persists, making fixed fees the more investor-friendly choice.

Important Note on Methodology: The portfolio returns used in this analysis are already net of our 1% annual fee and all associated charges. For consistency, we apply these same net returns when calculating alternative performance fee scenarios. This approach actually favors the performance fee models in our comparison, since the underlying returns don't reflect the drag of higher fees that would have been charged in strong performance years under those structures. In reality, performance fee models would likely show even lower final portfolio values due to the compounding effect of higher fees reducing the base for subsequent years' growth.

This conservative methodology ensures our analysis understates rather than overstates the cost differential between fee structures, making our conclusions more robust and credible.

Key Considerations for You

Whether we examine financial year returns or calendar year returns, whether the portfolio delivers 76% returns in one year or spreads its outperformance across multiple years, the mathematics remain unforgiving for performance fee structures.

The story doesn't end here. There are hybrid fee structures as well that combine the predictability of fixed fees with the upside participation of performance fees. Something like 1.5% fixed fee + 10% profit over 8% hurdle or other such combinations. 

While fixed fee models may feel costly during underperforming periods, they preserve significantly more wealth during strong performance years by not penalizing success. Since running a professional portfolio management service involves real operational costs, the annual fixed fee represents transparent payment for these ongoing expenses.  

The front-loading problem is real and persistent. These structures incentivize managers toward short-term decision-making, capture disproportionate value during market euphoria, and leave investors bearing the full downside risk during inevitable market corrections - a pattern that can significantly erode long-term investor wealth across market cycles.

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Read other sections of the guide here :

1. Introduction
2. PMS Explained: Professional Management with Direct Ownership
3. PMS vs. Mutual Funds vs. AIFs: Which Investment Route Works Best for NRIs?
4. PMS Inner Workings: Banking Partners, Custody Structure, and Trading Execution
5. Understanding PMS Fee Structures: Is ‘Skin in the Game’ Really in Your Interest?
6.  Is PMS Right for You? – Who Should Consider PMS and When

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At Capitalmind, we help NRIs optimize their Indian investments through compliant, growth-oriented strategies. For more details, reach out to us at NRI Desk

Disclaimer : This article does not constitute any solicitation of securities business from Residents of the United States of America or from a jurisdiction where accessing this without proper registration is restricted.