YOU don’t have to invest in stocks to invest in stocks (PMS/MF Basics)

Portfolio Management Service and Mutual Fund

“So we discussed about how to start investment in stock market through fundamental and technical analysis last time”, said Apurva, we started continuing our discussion where we had stopped last time.

“So fundamental and technical analysis are two important approaches for stock investment but it would be very difficult for a novice investor to understand the art and apply these approaches. where can I learn this art?” asked Apurva.

“Well it is true that it will take lot of time for anyone to learn it and it will only come through experience and academic knowledge. But does that mean one has to wait to perfect the art before they start investing in Stock Market? Certainly not. There are many who thought that they had perfected the art and invested their hard earnt money directly into stock markets and burnt their fingers”, I explained her.

“So what’s the way out”, asked curious Apurva. “Well you don’t have to invest in stocks to invest in stocks”, I knew this would confuse her as soon as I said it. “Huh!! What does this mean?” confusion was clear on the face of Apurva. “Don’t worry!! Let me Explain”.

So suppose your mom is going to get late tonight and you are hungry. What do you do, would you give it a try cooking Dal Rice, Roti-Sabji by yourself. “No, I cannot cook. Actually I know all the ingredients required for cooking the normal dinner, but I do not know the proportion of each ingredient that goes into making the dishes. I would not risk cooking today, I will rather order it from the restaurant nearby and pay up the bill”, said Apurva.

Exactly!!! You want to eat but cannot cook it yourself so you take help from the restaurant chef, order the food and pay up for his services.Similarly you can invest but not necessarily by investing yourself. “I kind of get you now, but can you explain it in more detail”. Of course, she now knew the concept but wanted to know how exactly one can do it. “There are two ways you can do this either through Portfolio Management Services or through Mutual Funds” I continued explaining her.

Portfolio Management Service (PMS)

So like our restaurant chef who is expert at making dishes, in Portfolio Management Services there are experts who are very experienced and knowledgeable people who use combination of fundamental analysis, technical analysis, technology, rules to guide you to invest the market. There are different type of such portfolio management services predominantly classified into 2 categories Discretionary & Non -Discretionary.

1.      Discretionary Portfolio Management  Services

In Discretionary Portfolio Management Services (PMS) you give your money to the expert and he will do the rest. He will buy/sell stocks based on his expertise. The ownership of the stock is with you but the execution part is done by the expert. The expert will not take your permission every time he executes a trade. You will certainly have access to view the securities you own and also will have access to several reports indicating your return on investments and overall exposure. In turn the expert will charge you fix amount of fees for his services and sometimes even part of the profit that you earn.

Example of such PMS services can be ICIC Prudential PMS: http://www.icicipruamc.com/

2.      Non-Discretionary Portfolio Management Services  

In Non-Discretionary Portfolio Management Service expert would give you advice on the things to be done. It can be with respect to the existing stock portfolio that you have or new recommendations that he may want to do. This recommendations is based on thorough analysis which includes fundamental analysis, Technical Analysis, any other rules /formula that the PMS would have arrived based on its previous experience. Such type of PMS services may or may not execute trade on behalf of you i.e. they will buy /sell security only with you permission else they cannot. The ownership of the securities in again with you. And such PMS services will mostly charge a fee for the advisory services that it provides and additional charges if it also executes trade on behalf of you.

E.g. www.safetrade.in.  Safe Trade is an Indian Portfolio Management Services Start up that received Best Finance Startup 2015 award and is also Red Herring Top 100 Asia Winner.

The PMS can also be classified based on the generic approaches as Active and Passive Portfolio management services. Active PMS providers are based on the approach that the markets are inefficient and hence it is possible to beat the average market returns by the strategy. Whereas the Passive PMS are generally believe in the principle that markets are efficient and it is possible to generate average market comparable results through their strategies.

Mutual Funds (MF)

In mutual fund there is typically a company known as “Fund” with portfolio manager managing the fund. It is similar to Discretionary Portfolio Management Services but differs from it on 2 grounds. In mutual fund you do not own the securities but you rather own units and the portfolio manager is not handling your money only but the “pool” of money from different investors hence the name “Mutual”. Let’s understand this by an example. If you have ₹ 1000 to invest, it is too small amount to invest in stock directly. Like you if there are 100 more investors.

MF portfolio manager pools the money from all, in our case it becomes ₹ 1, 00,000 and converts them into 10,000 units each of ₹ 10. So you now own 100 units. Now with ₹ 1, 00,000 that portfolio manager has got, he invests them in stock market using his expertise. Suppose he is able to get 5% return the total investment becomes ₹ 1, 05,000. And suppose he takes ₹ 1000 as the fees for his services then total investment value becomes ₹ 1, 04,000. Since there are 10,000 total units in existence, value of each unit is now ₹ 10.4 (1, 04,000/10,000). Since you own 100 such units, you can sell them and get ₹ 1040. So due to MF you could get return on investment of as low as 1000 which would have been very difficult had you wanted to invest directly by yourself.

“Oh. That’s the nice way to start investment. You do not have to directly invest in Stock market yet you can enjoy the return in the market by PMS and MF, obviously by paying fees for the expertise provided. So how to decide whether to go for PMS/MF and which one to go for?” asked Apurva. Let us not discuss everything today, we should leave some things for next discussion also. We both laughed to conclude the discussion with a promise to continue it next time.