Deepak was meeting me after a long time. Even though we were working and living in the same city for many years, we couldn’t meet. As a senior sales guy, he has a traveling job and that made it all the more difficult.
Finally, we did meet up.
The conversation was all around from college days to family and finally to investments. Yeah, you must have guessed it.
“Hey, it’s nice to know you are doing your own practice as an Investment Adviser.”
“Yes, it is very fulfilling.” I tried to reflect on the purpose.
“How have you been investing?” I asked.
“Nothing much, my bank RM keeps coming back to me with options and I put some of my money there. I also make direct stock investments based on ideas that I get from the market and advice from friends. I also get some insights from experts I follow on social media.”
“Hmm. Hmm.” I could sense where this was going.
He continued, “You know I have just spoken to this company and they have offered me to invest through their best PMS.
“PMS? Why?”
“See, I have made decent returns on the investments so far.”
“OK. How much?” I couldn’t resist this one.
“20% year on year easily.” There was a feeling of accomplishment in his voice.
“OK! You should check that on an excel using XIRR. Most people overestimate the returns they make.”
“Oh OK. I will.
So coming back, this company tells me that their flagship PMS has delivered around 33% CAGR in last 3 years…Amazing no! I had a detailed chat with them and planning to invest some money with the PMS. ”
“I am sure you know the ‘some money’ amount is a minimum of Rs. 25 lacs.”
“Yeah, yeah! That’s right. My stocks are valued more than that. I will just transfer it to them. But that’s not it. The overall package is great.
“And how is that?”
“See, they will put my portfolio in a dedicated account managed by a specialised team. The portfolio is also customised for me as per my preferences.
Since I am going for the discretionary option, I will have a complete say on what they are buying, holding or selling.”
“But why do you want to do that? As you said, they have done much better than you on your own. And you have a serious traveling job.”
“That’s right. But still. In case I need to, at least I have the option of getting my viewpoint across.”
“What are the fees and charges?”
“Quite clear. 2% upfront on sign up. There is a 1% per annum fund management fees. They will also have a profit share of 20% for returns above the benchmark hurdle rate. Their benchmark is BSE 30 – Sensex.
If they deliver 20% return and Sensex return is 15%, then they will take 1% (20% of 5%) as profit share.
I like this profit sharing concept. This will get them to work harder. ”
“Wow! That’s nice. I see why you are so attracted by the idea.”
There were more questions.
“But Deepak, don’t you think the BSE 30 Sensex benchmark is a very low hurdle?” I posed the question to him.
“Why do you say so? BSE Sensex is an internationally tracked benchmark.”
“See, it is very easy. One can have a large cap benchmark such as Sensex, then it can crossover to invest in mid cap / small stocks and beat the Sensex out black and blue. This enables one to have a higher absolute share of the profits above the hurdle rate.”
“Hmmm. Yes. I see your point.”
“That brings me to the next question. Have they defined their investment strategy? What kind of stocks they would invest in? Any things they won’t do or will do?”
“Well, I think they would invest in high growth companies across the market.”
“In that case, their benchmark should be a Nifty 500 or BSE 500. I am still not sure where they will invest. If they end up investing in more mid cap or small cap then a mid/small cap benchmark such as BSE Mid cap is more appropriate.”
“Let me quickly check that. I have the email.”
Deepak checked and said, “Ok, here it is. They will invest in high growth small and mid cap companies.”
“There you have it. You should ask them to have the BSE Mid cap as the benchmark.”
“Yes, I should talk to them about it.”
I now had to pose to him the big question.
“Deepak, Why not mutual funds?”
He thought and replied. “Well, I have some investments in mutual funds too. My banker got me to do some SIPs. But you know, mutual funds are so boring. There is absolutely no participation except looking at NAVs and factsheets. In contrast, stocks keep you more engaged.
See, I always wanted to invest in direct stocks. Now since, I can get someone to do a better job, I am thinking to go for the PMS. Because it is a discretionary PMS, I also get to have a say.”
“Why is that excitement necessary Deepak? In any case, you haven’t had great results investing yourself compared to the PMS.
If you truly believe someone can do a better job than you, then why not just handover the decision making also. You review it on a regular basis and that’s it.”
“Hmm… I know what you are saying. Still…”
I interrupted him. “What matters to you more? Better performance or to be able to give your opinion?”
“Of course performance.”
“OK. What if I tell you that a Mutual Fund is likely to give you better returns with less headache?”
“Are you serious? Impossible!”
“OK. We will let the numbers speak.
We will take some mutual funds from the mid cap, small cap and flexi cap (that invest across the market) categories. See the charts below.
1. Mid cap Mutual Funds performance (point to point returns)
2. Small cap Mutual Funds performance (point to point returns)
3. Flexi cap Mutual Funds performance (point to point returns)
All returns are based on NAV as on Oct 18, 2016.
“Flexi caps are more spread out and diversified in nature, while the other two are focused on their respective market capitalisations.
Now as you can see, the mid cap and small cap funds have delivered superior returns than what the PMS claims it has done.
There are funds which have delivered 30% to 50% CAGR over the last 3 years and around 25% to 30% in the last 5 years. This is after deducting all the expenses.
I don’t know if the PMS returns, you have been told, are pre or post expenses.”
“Amazing! How come I didn’t notice this?”
“Because you think mutual funds are boring!” I said immediately. Deepak smiled.
“On top of that, mutual fund expenses are far less than that of a PMS. There is no upfront 2% charge or a profit share. The overall expenses of a mutual fund are about 1% to 2% per annum.” I continued.
“Oh my! Now that you are saying it, I have to reconsider my decision. Just tell me if I can invest large amounts of money in mutual fund in one shot, say half a crore.
“Yes, you can. There might be investment limits in some schemes, but most of them accept large investments too.”
“Let me tell you one more thing. A lot of PMS schemes are also offered by Mutual Fund companies. In several cases, they are just replicas of their flagship schemes. Since there are people who would want a specialised experience, they go for the PMS option with a dedicated account manager and fancy words like ‘for the sophisticated investor, high end strategies, which may not add as much value. In fact, PMS schemes, just because of their additional charges and profit sharing, could give you lower returns in comparison to mutual funds.”
“Thanks man. I must confess I did fell for those fancy words. Anyways that’s a lot of helpful information. I should seriously consider mutual funds as an investment option.”
“Way to go, Deepak.”
“Let’s order some more tea.” I said.
“Sure.” Tea was our favourite drink.
Disclaimer: Past performance does not guarantee future returns. The mutual fund schemes used in this post are only for example and are not to be treated as recommendations or investment advice.