Mutual Funds, Portfolio Management Services (PMS) and Alternative Investment Funds (AIF) are all investment vehicles, where your equity or debt investments are managed by professional fund managers. Each of these investment options has their own pros and cons. The most suitable investment vehicle for your investments, would come down to your unique requirements.
In this post, we identify the key positives and negatives of each of the 3 investment options, to help you understand what would be the best for you.
Mutual Funds – Pros & Cons
Pros
- Very Small Min Investments
- Highly Tax-Efficient
- Ease of Operations
- Systematic Investment / Transfer / Withdrawal Possible
- Typically Low-risk Diversified Portfolios
Cons
- Lower Risk leads to Lower Returns
- Low Differentiation
- Risk of Fund Manager Changes
- Targeted at Retail Customers
Mutual Funds are clearly the most popular investment vehicle, given their ease of investments and the low initial investment requirements. They are also highly tax-efficient (debt funds having long-term capital gains benefits and equity funds only being taxed on redemption, and not when the portfolio is changed).
The ability to do SIPs / STPs / SWPs, also make them a very convenient vehicle to reduce the risk of market timing. This is very valuable from a financial planning perspective.
These benefits make Mutual Funds a very good option for most investors, including HNI’s.
The main drawback of mutual funds, is that the structure does not make it easy to offer more differentiated and higher risk-return strategies. This does limit the return potential of mutual fund investments, which is where a number of HNI’s also seek to invest in PMS or AIF strategies.
Additionally, Mutual Funds also have the risk of fund manager changes, which is reduced substantially in the case of owner-managed PMS & AIF schemes.
Portfolio Management Services – Pros & Cons
Pros
- Differentiated Strategies
- Larger range of risk-reward options
- Customised Portfolios Possible
- Direct Ownership of Stocks
- FM Stability (owner-managed PMS’s)
Cons
- 50 lakh Min Investment
- Tax Disadvantage
- Large Number of Lower-quality schemes
- Leverage & Shorting Not Allowed
With minimal regulatory and minimum corpus hurdles, the PMS platform is the easiest investment vehicle for fund managers to launch and run differentiated investment strategies. This allows for a large number of differentiated strategies, with varying risk-return ratios, that would appeal to more sophisticated investors. Additionally, the PMS platforms also allows for equity portfolios to be customised to meet the unique requirements of individual investors.
In recent years, a large number of very high-quality fund managers have left their senior investment positions at top AMC’s to set up their own PMS house. This provides investors with confidence on the long-term stability of the core fund management team.
While PMS’s do offer investor’s considerable advantages, there are few important challenges as well. A minimum investment of Rs. 50 lakhs, makes PMS’s out of reach for most retail investors. As PMS investments are tax-pass through vehicles (it is considered that the investor is investing in equity shares themselves), they do not offer the same tax advantages as mutual funds.
While there are a number of very high-quality PMS schemes, there are an equally large number of lower-quality schemes. This makes it very important that the investor & the advisor, have a good understanding of the true risk-reward prior to investing.
Lastly, restrictions around shorting and leverage, restrict PMS houses from launching the more complex strategies that are possible under the AIF structure.
Alternative Investment Funds – Pros & Cons
Pros
- Highly Complex Strategies Possible
- Larger range of risk-reward options
- FM Stability (owner-managed AIF’s)
Cons
- 1 cr Min Investment
- Tax Disadvantage
- May be Difficult to Understand True Risk-Reward
AIF’s are the most flexible of the three investment vehicles, allowing for investments in unlisted shares, along with the use of leverage and shorting. This allows for AIF’s to offer strategies of much higher levels of complexity, as compared to what is possible under PMS or Mutual Fund Structures. This leads to the highest range of risk-reward options that are available to investors.
AIF’s are categorised into 3 categories – Cat 1 (investments in early-stage & start-up ventures), Cat 2 (those that do not fit in Cat 1 or 3) and Cat 3 (funds that employ diverse or complex strategies, including the use of leverage).
In recent years, a large number of very high-quality fund managers have left their senior investment positions at top AMC’s to set up their own AIF’s. This provides investors with confidence on the long-term stability of the core fund management team.
While AIF’s do have the ability to offer investor’s complex and differentiated investment strategies, they do have some disadvantages. A high Rs. 1 cr minimum investment, makes AIF’s clearly out of reach for most retail investors.
Additionally, AIF’s do not offer investors the same tax advantages as mutual funds. Cat 1 & Cat 2 AIF’s are taxed as pass-through vehicles (from a tax perspective, it is considered that the investor has directly made the investment themself). Cat 3 AIF’s are taxed at the fund level, based on the type of income (business income, capital gains and dividend).
Some of the more complex trading strategies adopted by AIF’s, may be difficult for advisors or investors to truly understand. This can potentially lead to investors making investments, with a true understanding of it’s risk-return.
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