NISM Series XXI-B Short Notes – Part 4: Operational Aspects of PMS & Portfolio Management Process
This is Part 4 of our 10-part NISM XXI-B short notes series on PassNISM.in. This part covers Chapters 8 and 9 — the operational side of running a PMS business and the complete portfolio management process including asset allocation, IPS, and rebalancing.
👉 Also Read: Part 3: Derivatives, Mutual Funds & Role of Portfolio Managers | Free Mock Test
Chapter 8: Operational Aspects of Portfolio Managers Who Can Invest in PMS?
The following entities are eligible to invest in Portfolio Management Services (PMS):
Individuals, Non-Resident Indians (NRIs), Hindu Undivided Families (HUFs), Proprietorship firms, Association of Persons (AOP), Partnership firms, Limited Liability Partnerships (LLP), Trusts, and Body Corporates.
📌 Minimum Investment Requirement: ₹50 Lakhs
A portfolio manager shall not accept funds or securities worth less than ₹50 lakhs from any client. Investments can be made in cash, in securities, or a combination of both.
Global Investment Performance Standards (GIPS®)
GIPS are ethical standards for calculating and presenting investment performance, based on the principles of fair representation and full disclosure. Key points:
- Created for investment firms managing composite strategies
- Provide a standardized method for presenting performance to prospective clients
- Help both existing and prospective clients compare investment managers fairly
- Promote greater uniformity and comparability among investment managers globally
Client On-Boarding Process
To invest in PMS, a client must complete the following steps:
- Read the Disclosure Document – The portfolio manager must provide a disclosure document with all relevant information about services, fees, risks, and past performance.
- Fulfil KYC Requirement – Know Your Customer (KYC) documentation must be completed.
- Submit Duly Filled Application Form
Joint Holding in PMS
PMS investments can be held jointly. Investment records are created in the name of the first holder. All benefits — dividends, interest, and redemption proceeds — are credited to the first holder's account.
Redressal of Investor Grievances
Portfolio managers must take adequate steps to resolve investor complaints within one month of receiving the complaint. They must also keep SEBI informed about the number, nature, and other details of complaints received. The agreement between the portfolio manager and client must include provisions for grievance redressal.
Disclosures Required by Portfolio Managers
- Disclosures to SEBI – Periodic reports as required by regulation
- Disclosure to Financial Intelligence Unit (FIU-India) – For anti-money laundering compliance
Fees & Costs in PMS
The following are the main costs borne by PMS investors:
- Investment Management and Advisory Fee
- Custodian / Depository Fee
- Registrar and Transfer Agent (RTA) Fee
- Brokerage and Transaction Cost
- Certification Charges, Fund Accounting Charges & Professional Fees
- Out-of-Pocket and Other Incidental Expenses
High Water Mark & Hurdle Rate (Exam Favourites)
- High Water Mark: The highest value a portfolio has ever reached. Performance fees are charged only when the portfolio value exceeds this previously achieved peak. This protects investors from paying performance fees twice on the same gains.
- Hurdle Rate: A minimum benchmark return that must be exceeded before the portfolio manager can charge performance-based fees.
Example: If a portfolio's high water mark is ₹1.2 crore and it currently stands at ₹1.15 crore (below the mark), no performance fee is charged — even if the portfolio has grown this year.
Chapter 9: Portfolio Management Process The Importance of Asset Allocation
Asset allocation is the process of deciding how to distribute an investor's wealth across different asset classes. Professional investment experience shows that in the long run, asset allocation is the single most influential factor in portfolio performance — more than individual security selection or market timing.
Asset allocation is not a standalone decision — it is an integral component of the entire portfolio management process.
Correlation Across Asset Classes
Correlation measures the strength and direction of the relationship between two variables. It ranges from -1 to +1:
- +1: Perfect positive correlation — both move together
- -1: Perfect negative correlation — they move in opposite directions
- 0: No relationship
Understanding correlation is crucial for effective diversification. Lower (or negative) correlation between asset classes means combining them reduces overall portfolio risk. Correlations can and do change over time and across economic conditions.
Steps in the Portfolio Management Process
- Development of Policy Statement (IPS)
- Study of Current Financial Conditions
- Construction of Portfolio
- Performance Measurement and Evaluation
Investment Policy Statement (IPS)
The IPS is the single most important document in portfolio management — it's the roadmap for the entire investment process. It specifies:
- Investment objectives and goals
- Risk tolerance and risk capacity
- Investment constraints (liquidity, time horizon, tax, legal, unique preferences)
Key Investment Constraints
- Liquidity Constraint: How quickly does the investor need access to funds?
- Regulatory Constraint: Are there legal restrictions on what can be invested in?
- Tax Constraint: Tax implications of investment decisions and portfolio transactions.
Assessing Investor Needs
People invest to achieve various financial goals — some short-term, some medium-term, some long-term. Some goals are high priority (retirement, child's education) while others are lower priority (vacation, luxury items). A good portfolio manager assesses all goals and their relative importance.
Analyzing Investor's Financial Position
A convenient way to organize an investor's financial data is through personal financial statements:
- Statement of Net Worth (Balance Sheet): Total Assets – Total Liabilities
- Income-Expense Statement: Income inflows vs. expense outflows
Psychographic Analysis of Investors
Psychographic analysis bridges the gap between standard finance (which assumes fully rational investors) and behavioural finance (which recognizes real-world biases and emotions). It acknowledges that investors are normal human beings susceptible to biased and irrational behavior.
Five Investor Personality Types
| Personality | Characteristics |
|---|---|
| Adventurer | High risk tolerance, confident, willing to take large bets |
| Celebrity | Follows the crowd, influenced by popular trends and personalities |
| Individualist | Independent thinker, analytical, confident in own decisions |
| Guardian | Highly risk-averse, prioritizes capital preservation |
| Straight-Arrow | Balanced, moderate risk tolerance, balanced approach |
Life-Cycle of Investment
| Phase | Description |
|---|---|
| Accumulation Phase | Early career; high income-to-expense potential; focus on wealth building |
| Consolidation Phase | Mid-career; earnings exceed expenses; portfolio grows significantly |
| Spending Phase | Post-retirement; portfolio used to fund living expenses |
| Gifting Phase | Surplus beyond spending needs; estate planning and wealth transfer |
Strategic vs Tactical Asset Allocation
- Strategic Asset Allocation (SAA): The long-term target portfolio allocation based on the investor's characteristics, goals, and risk tolerance. It is the policy portfolio — the anchor of the investment strategy.
- Tactical Asset Allocation (TAA): Short-term deviations from SAA to take advantage of market opportunities. TAA decisions are made more frequently and are designed to add alpha by exploiting market inefficiencies temporarily.
Portfolio Rebalancing
Over time, asset prices change at different rates, causing the actual portfolio allocation to drift away from the target (SAA). Rebalancing is the process of bringing the portfolio back to its original risk-return target.
Why Rebalance?
- Asset classes produce different returns, changing the portfolio's allocation
- Changes in investor's goals, risk tolerance, or life stage
- To prevent the portfolio from taking on unintended levels of risk
Quick Revision Box – Part 4
- PMS minimum investment = ₹50 Lakhs (cash + securities)
- Investor grievance resolution = within 1 month
- High Water Mark = protects investors from double performance fee
- IPS = the roadmap for portfolio management
- SAA = long-term target; TAA = short-term active bet
- Life cycle: Accumulation → Consolidation → Spending → Gifting
- GIPS = global ethical standard for investment performance presentation
👉 Continue Reading: Part 5: Taxation & Regulatory Aspects of Portfolio Management
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