Most PMS schemes offer better return than benchmarks, but there is a loophole

A majority of the schemes by Portfolio Management Services (PMS) may be outperforming against their benchmarks thanks to a regulatory loophole that allows them to showcase outperformance, an analysis of the filings by the schemes showed.

Experts say that PMS players typically choose BSE 500 or Nifty 50 as the benchmark, irrespective of whether the fund is dominated by small or mid-cap shares. In other words, given that the benchmark includes a several large-cap shares too, which, though more stable from a longer term perspective, could be giving comparatively `lower returns compared to a small or mid-cap company. This allows PMS fund managers with small or mid-cap schemes to report a higher return than a large-cap dominated benchmark index.

This is not a violation of any regulatory provision as equity PMS schemes have the option of benchmarking only against S&P BSE 500 and NSE 50 indices, as per the Securities and Exchange Board of India (SEBI) regulations. However, this framework is the reason for PMS' performance not being measured correctly.

An analysis by Moneycontrol showed that around 73 percent of the total PMS schemes categorise themselves as ‘mid-cap’, and have underperformed their true benchmark, in CY24. On the other hand, as many as 56 percent of the total PMS schemes that categorised as ‘small-cap’ underperformed their true benchmark.

For CY24, out of the total 22 strategies that categorised themselves as ‘mid-cap’ schemes, 14 have outperformed the broad S&P BSE 500 TRI index. A closer analysis showed that only six of these outperformed the true S&P BSE TRI 150 index.

The story is similar for small-cap strategies too. For CY24, of the total 18 strategies that categorised themselves as ‘smallcap’ schemes, 14 have outperformed the broad S&P BSE 500 TRI index. The number dips to eight if the performance is measured against the S&P BSE 250 TRI index.

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Fund managers argue in favour of S&P BSE 500 as the benchmark so as to maintain flexibility, allowing them to shift to large-cap stocks during periods of market volatility.

“The marketing material may label the strategy as a small-cap scheme, but it will be benchmarked against the S&P BSE 500 to provide a cushion for safeguarding returns,” said Sagar Lele of Rupeeting. While the fund's long-term focus remains on small-caps, fund managers may shift to large-caps during phases of correction or small-cap underperformance, and return to small-caps when the market rebounds.

"The issue arises when these strategies label themselves as small-cap funds instead of multi-cap or flexi-cap funds," said a person on the condition of anonymity. If a fund manager intends to take positions in mid and large-caps, the fund should be categorised as multi-cap or flexi-cap instead, he added.

“PMS strategies prefer using a broader index like S&P BSE 500 as their benchmark instead of a pure small-cap index since it is highly volatile, making it harder to outperform,” said a distributor wishing not to be named. He added that by choosing S&P BSE 500, which includes small-cap stocks but has a huge weightage of large and midcaps, PMS funds can show better performance more easily.

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Some small-cap PMSes also benchmark themselves against a Nifty 50 index since there is no strict benchmarking rule. "In a period when the Nifty 50 is the worst performer in terms of returns, comparing a small-cap scheme to Nifty 50 index is absolutely wrong," said a fund manager with a large PMS advisory.

SEBI had provided a list of 32 additional secondary benchmarks for PMS strategies in October 2024, but the selection of a secondary benchmark is purely optional.

It is not necessary for PMS players to display the secondary benchmark on the Association of Portfolio Managers in India (APMI) website, but it should display the secondary benchmark in all the communications to investors, said Pallava Rajan, founder and director of PMS Bazaar.

However, the benchmarking standard for mutual funds is different and more transparent compared to PMS. For a mutual fund, the regulations demand strict cap on weightage, on whether it is a mid or a small-cap fund.

According to SEBI regulations, a mid-cap mutual fund must invest at least 65 percent of its assets in equities and equity-related products of mid-cap companies. Same goes for small-cap where at least 65 percent of its assets must be in small-cap companies.

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In a PMS, however, the regulations do not demand such strict capping. “There is no regulatory rule, PMS players can change their strategy whenever they want, if a material change is disclosed in advance to customers,” said Deepak Shenoy, founder of Capitalmind.Disclaimer: The views and investment tips expressed by investment 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.