Please read the end of this article for an update.
A few days ago, a report stated that market regulator the Securities and Exchange Board of India (SEBI) is actively considering limiting the fees that Portfolio Management Services (PMS) can charge from customers. PMS services -- which are often wrapped in terms like wealth management -- are sold on a premise of managing investors’ portfolios on an individual basis, customised to each customer's needs. PMS' charges can range from a flat fee or a performance-linked one.
The performance-linked fee is generally in the form of an about 2 per cent fixed, plus about 20 per cent of profits above a certain index-linked level.
PMS fees are certainly high, but that's not the main problem with them. The drawback is that there is a complete lack of transparency, along with all the other ills that come with it. Coinciding with the appearance of the PMS fees report, I was contacted by an acquaintance who wanted some advice on whether he should take up the services of a PMS that had approached him -- he was attracted by the gains promised. He had been told that the PMS investment was likely to make for him 8 to 10 per cent a month. This is an astounding number. 8 or 9 per cent a month compounds to a gain of about 150 per cent a year. If money grew at this rate, it would be around 20 times the starting value some time during the third year.
This is a completely outlandish claim that would be impossible to sustain under any possible circumstances. If there exists an investment manager in the world who can do this then he or she would stop working for others and quickly become one of the richest people in the world. Yet such claims are made routinely. However, they are made orally and with vaguely stated caveats that make them meaningless. Unfortunately, those who make these claims understand human nature very well. Once a susceptible victim has heard '8 per cent a month', his mind is completely full of fantasies about what he could do with such wealth. It's like an infatuation, where the infatuated simply will not pay any attention to anything that detracts from the qualities of his infatuation's target.
The real issue here is the utter lack of transparency and verifiability. PMS is a secret business. No data is ever available about what exactly was earned by any PMS client. When you ask a PMS salesman about performance, he comes out with these fantasy numbers that are not verifiable in any possible way. The PMS and wealth management businesses hide behind the fact that they can't reveal other client's confidential information so they can't give anyone verifiable numbers about their investment performance.
This is a completely spurious argument. It would be easy to set up a framework of transparency whereby trustable, auditable yet anonymous data about actual PMS performance can be made available. If every other kind of financial service provider can provide aggregated data without revealing customers' identity then portfolio managers and wealth managers can do so too.
In practice, the real problem with PMSs is not that their services are expensive, but that their services may actually be non-services and yet no potential customer can ever discover that.
Update: I've got a tremendous amount of readers' mail about PMSs after this article was published. All of it is heavily critical of PMSs. If this was a real service that did something useful for its customers, wouldn't it have a great deal of word-of-mouth promotion? The fact that no one has a good word to say about portfolio management surely says everything about it.