Where to invest in a volatile market

The equity markets have been on a roller-coaster ride in the past few weeks. While India is relatively shielded from the sub-prime problem, its alignment to international markets and an increased presence of foreign investors, especially hedge funds, has made our stock markets move in tandem with global markets.

Investors at this time are facing the all-important question of how to insulate themselves from this heavy volatility? To answer this question, let us look at the options available for an equity investor.

There are three main investment avenues for a person wishing to invest in equities. These are direct equities, equity mutual funds and portfolio management schemes. Many investors prefer direct equities, since it gives them the freedom to make their own decisions and adequate flexibility to manage their portfolios.

However, most investors are lost as to what and when they should buy or sell, and often rely on market tips, which can be dangerous. Others prefer mutual funds, especially through the systematic investment plan route, since it gives them professional fund management expertise and zero headache, but at a higher cost.

However, the third alternative provides investors the best of both worlds. Let us look at what a PMS is and how it can help an equity investor, especially in these uncertain markets.

A PMS is generally offered by leading asset management companies, stock broking houses, and independent portfolio and wealth management firms. The minimum investment criterion is Rs 500,000 according to the Securities and Exchange Board of India guidelines, though most players set much higher cut-off limits.

In a PMS, the portfolio is generally much smaller in assets and is much more concentrated with lesser number of stocks than equity mutual fund schemes.

PMS schemes can have different management styles. The most common is discretionary PMS, where the portfolio manager takes all the decisions regarding investments, just like a mutual fund manager.

It can also be non- discretionary, where investment decisions are taken after the client's consent, or advisory, where the client is just given advice on trading and takes his own decisions.

Benefits

Let us now look at the reason why a discretionary PMS is preferred by most savvy investors over both direct equity and equity mutual fund investments.

It is an ideal investment tool for investors who don't have either the time or the expertise to handle their own portfolios, or who tend to get biased or carried away by emotions of fear and greed, when making their own investment decisions.

There is a wide choice of PMS schemes to choose from, similar to mutual funds. They can be diversified equity PMS, large-cap, small/mid-cap, sectoral, dividend yield, etc.

PMS goes a step further and can create a tailor-made portfolio for a client.

The investor has a choice of making the investment in PMS by cheque or by giving shares.

The costs are higher than direct equity investments, but lower than mutual funds. Investors even have the choice of paying PMS fees as a percentage of portfolio value or as a percentage of profits earned or both. If an investor chooses the percentage of profits method, the portfolio manager does not earn until they make profits for the investor. Therefore, the pressure to perform is much higher on the portfolio manager.

However, the biggest advantage of PMS is the way they are allowed to operate. One, they are allowed to shift from being fully invested in equities to 100 per cent cash at any time. This enables the portfolio manager to take tactical asset allocation calls and shift to cash if he is temporarily bearish on the market.

This is one thing most mutual funds cannot do, since their schemes are such that they have to stay invested in equities up to a certain minimum limit (which can be as high as 90 per cent) and cannot go below that, even if they are bearish on the market.

Two, PMS are allowed to hedge their exposure through derivatives, thus protecting the portfolio from market volatility. Some mutual funds have also incorporated this strategy into their schemes. Third, PMS also have the facility to set triggers for account deactivation if the portfolio value falls below a certain amount.

All these factors weigh heavily in favour of PMS in volatile markets, provided they are managed well. It is easier for the portfolio manager to sell or hedge a smaller and more concentrated portfolio.