Alternative Investment Fund and Portfolio management services often have similar frameworks; however, they are intended for a different audiences. A closer look at their mandate would reveal the differences between these two niche investment vehicles. Both of these services are private wealth management services offered to HNIs and foreign nationals. We look at the advantages and disadvantages of AIF and PMS. Before that, we look at the difference between these two asset classes.
Difference between AIF and PMS:
AIFs invest in alternative investments. They are asset classes different from conventional equity and debt. Alternative investments include structured products, commodities, hedge funds, real estate, private equity etc.. Unlike PMS, AIFs are a pool of money, as in the case of mutual funds, such money is invested in a set of assets which are beyond the conventional asset classes. These funds are aimed explicitly at HNIs and Foreign Nationals. This helps the portfolio diversify into asset classes which are otherwise beyond the scope of one’s investment.
There are 3 categories of AIF: Category 1, category 2, and category 3. As mandated by SEBI, the minimum investment in AIFs is Rs. 1 Crore.
- Category 1 allows investment in early-stage ventures, social ventures, SMEs, infrastructure or other sectors that the regulators consider economically important.
- Category 2 allows investment in funds such as PE or private equity funds, real estate funds, distressed assets funds, etc.
- Category 3 allows investment in hedge funds and other assets which focus on short-term gains.
These funds typically have a lock-in period of ~3 years, and the number of investors is typically restricted to 1000, except in the case of angel funds.
On the other hand, PMS refers to a professionally managed portfolio of investments in assets, including debt and equity. They aim at homogenous investors willing to undertake a certain amount of extra risk on their portfolio with enhanced exposure to familiar asset classes, including equity and debt. There are 3 types of PMSs:
- Discretionary:
In this type of PMS, the fund manager or portfolio manager undertakes the investment decisions independently. - Non-discretionary:
In this, the investor (client) has to approve all buy-sell transactions. Only upon approval, the portfolio manager is allowed to execute the transactions. - Advisory:
Here, the portfolio manager provides expert advice to the investor. It is up to the client (investor) to follow the advice and execute the plan.
The minimum investment amount as per SEBI mandate for PMS set-up is Rs. 50 lakh.
Advantages and Disadvantages:
- AIF – Advantages (as compared to PMS)
- Diversification:
This investment vehicle offers diversification beyond the familiar world of debt and equity. It also offers a chance to own relatively complex asset classes. They require specialised knowledge for management. You would probably, otherwise, not indulge in this arena as the required knowledge is vast.
- Lower volatility:
The volatility is lower in the case of these funds in certain cases, as the asset classes are not intensely speculated upon. However, the exception is hedge funds. The others are invested with a relatively long-time horizon.
- Lower transaction cost:
The asset selection process is quite intense; however, the portfolio turnover is lower. This leads to overall lower transaction costs; however, the fund manager requires exceptional expertise across a very complex set of products, and this could potentially drive the fund management costs.
- Direct ownership:
This fund provides the opportunity for direct ownership in asset classes such as early-stage investing, venture capital, and private equity. This gives a greater sense of control and provision for potential control over the business operations. Thereby providing the ability to steer the business in a certain direction.
- Tax benefits:
Most investments are held for at least 3 years, thus attracting tax benefits in the form of indexation in the case of debt or real-estate-oriented assets. For equity, the long-term capital gains are lower if the asset is held for over 12 months.
- Potential for higher income:
Since the investment selection is intense and is typically for the longer haul, there is potential for supernormal returns. However, this comes at a higher risk as well.
- AIF – Disadvantages (as compared to PMS)
- Higher entry point:
The minimum investment threshold is quite high. It is targeted at a select audience, thereby rendering a large part of the investor population out of the arena.
- Complex product features:
The product has a very complex design to accommodate a set of complex underlying products. This requires a deeper understanding of market dynamics across various products to make an informed decision.
- Liquidity concerns due to lock-in:
These funds have a lock-in of 3 – 10 years, hence raising liquidity concerns around the investments.
- PMS – Advantages (as compared to AIF)
- Customisation:
PMS offers a deep level of customisation and is aimed at a set of homogenous investors. It continues to invest in familiar territory, however directly aligned with the intended risk-return preferences of the investors.
- Transparency and accountability:
The transparency and accountability in the case of PMS are quite high. They offer sophisticated tools and login to look at the portfolio anytime, anywhere. Complex yet insightful analytics are conducted on PMS to enable better transparency.
- Complements the portfolio:
PMS is only an extension of your current portfolio with deeper exposure to familiar territory. It is intended to complement the existing portfolio and not add a very divergent angle.
- Liquidity:
PMS does not have any lock-in as in the case of AIF, which remains one of the most attractive features.
- Low fees:
As compared to AIF, the fund management fee is lower as they are dealing with investment avenues which are still conventional in a sense. The fee is higher than that of MFs but lower than AIFs.
- PMS – Disadvantages (as compared to AIF)
- Higher transaction costs:
As compared to AIF, the turnover is higher in the case of PMS. Hence, the transaction costs are relatively higher.
- Tax implications:
Since the portfolio is churned more frequently, tax implications impact the portfolio’s performance.
- Redemption pressures:
As there is no lock-in, the redemption pressures loom large on PMS as compared to the other avenue.
Both AIF and PMS are specialised services aimed at HNIs in particular. AIF is a step ahead of PMS, as the ideology is more progressive. Investing in either of these avenues requires enough knowledge and expertise. Reach out to our financial counsellors at TATA Capital, who will help you decide which avenue will complement your existing portfolio and financial requirements.
06 September 2022
6 mins read
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