More than Rs 3 lakh crore of wealth is managed by PMS: How do the ultra-rich invest?

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Wealth reduces risk appetite. We fear losing more than the pleasure from winning. This is not anecdotal but can be seen in data as well. If you look at the premium you need to pay for protecting your wealth with a put option vs an option to claim an upside with a call, the put is on an average 20% more expensive.

In simple terms, people are willing to pay almost 20% more to protect the downside than the chance to claim the upside for the same odds.

This phenomenon has been researched a lot in academics. It quantifies loss aversion where losing hurts more than the pleasure of a similar gain and this makes us conservative.

That said, the risk is the reason why returns are made. Having interviewed some of the family office clients, we see that most often they think of wealth as a multi-generational continuum instead of bucketed goals.

One of the first needs is simple to understand reports of their exposure and ability to drill down into each of the allocations if needed. Next, they want to know their cash flows.

A cash flow projection to illustrate when their investments will return cashback is important for them to be able to plan future investments. Finally, they seek a conversation and a solution of products to meet their needs.

Some of the most sophisticated private bankers are able to provide this service but the number of potential customers far outstrips the supply of such talent, hence technology can help to scale quality at an affordable price.

Looking at the product landscape in India, currently, there are close to two lakh PMS accounts in India where the minimum investment is 50 lakh. As of recent data, the total investment in PMS is above 3 lakh crore.

Another category that UHNIs often use is AIFs where the minimum investment is 1 crore. There are Rs 46k crore in AIF Cat III funds that are both open-ended and close-ended.

This is the Indian version of hedge funds. Roughly 144 of them exist in India. Most of them are set up as trusts to protect the privacy of their investors but there are also a few setups as close-ended LLP to take benefit of the lower taxation.

Other categories include AIF category I and II. The total assets in AIF in category I is about 40k crore, which is usually VC funds like social venture funds, infrastructure funds, venture capital funds, and SME funds.

Typically these compete with angel investment networks. However, the largest category is AIF category II which has about 4 lakh crore in assets which invests in debt and private equity.

Apart from these choices, there are structured products, syndicated loans, P2P lending, etc, that have been the mainstay for years. According to CARE Ratings, there is about 17k crore in structured products.

This landscape may see a radical change as SEBI allows an accredited investor regime where once you qualify, you will have a lot more freedom to choose how you want to be investing.

For example, we might see PMS investing in start-ups where 100% investments in unlisted equity would be allowed for accredited investors with a net worth above 10 crores.

Currently, there are more than 270 PMS and more than 750 AIFs registered in India. Within these, there is probably almost the same number of schemes available for UHNIs as 1730 odd mutual fund schemes in India.

While mutual funds have 25 lakh crore, there is less than 10 lakh crore in the UHNI products and few of the funds have most of the assets.

This makes this a highly competitive space and naturally needs higher fees to be sustainable. There might be continued consolidation in this space. Hence, it is important to choose well in this space.

How to structure the portfolio for a UHNI

A portfolio is a solution in our view. It must exist to cater to the needs that are personal and special. We also think it should be simple with a minimal number of funds. An approach that we think works well is a core-satellite framework.

Keep simple and easy-to-understand products in the core part of the portfolio. We think most of this can be addressed by mutual funds even for UHNIs. This could also be a place for long-term illiquid but easy-to-understand products like tax-free bonds, close-ended funds, structured products etc.

Though PMS can also be part of the core portfolio, one needs to check for the holdings overlap of the PMS with the focused fund category in the mutual fund which might be the cheapest way to add to the core exposure.

Based on our experience, we have seen many portfolios which has 30-40 mutual funds that have a lot of overlaps. The first thing one can do is rationalize the exposure to a simpler portfolio.

Fund house diversification is less critical if there is strong monitoring of the portfolio. For example, increasing receivables at the fund level was easily seen in Franklin funds before it was closed.

An advisor could have reacted to this data and moved client money away. Similarly, a good advisor will advise you when NFOs are appropriate.

For example, we think NFOs make more sense for closed-ended funds where future exposure might not be possible. For open-ended NFOs, there is usually a similar product with an existing track record.

Hence, unless very differentiated, we usually don’t think NFOs make sense as a general first choice for open-ended funds.

Having discussed, core allocation, the satellite is where ambitious allocations and niche products can enhance the returns. These could also be slightly more expensive as the allocations are smaller than in the core portfolio.

The satellite can be 20-30% of the portfolio. There should however be not more than 10-15 products in your portfolio overall even if you are working with an advisor. The satellite can have upto 10 products while the core may have up to 5 products.

Core portfolio should be reviewed annually with quarterly monitoring meetings while satellite can be tactical in nature and adjusted based on opportunities more frequently.

In our opinion, a satellite portfolio could have global equity AIF, illiquid assets, alternative products etc. You may invest in 1-2 AIFs that do VC/PE, SME lending, levered long-short funds, PMS Etc. in this part of the satellite allocation.

How to monitor portfolios

Often right questions you can ask your advisor are an important first step. Few questions that can be very revealing are for example, are there similar products in terms of risk-return that could be cheaper?

What is the specific reason for choosing a specific fund vs other similar ones? Is there a more tax-efficient way to get exposure to this kind of allocation?  Can you give me a client reference who has benefited from your service? Once you have these answers, often you can make many decisions yourself.

(The author is CEO Lotusdew)

Disclaimer: The views and investment tips expressed by experts on Moneycontrol.com are their own and not those of the website or its management. Moneycontrol.com advises users to check with certified experts before taking any investment decisions.

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