Capital markets regulator Securities and Exchange Board of India (SEBI) has brought in some changes related to commission disclosures, in case of PMS products, which will be applicable from October 1, 2024.

These are some of the key changes :

A. While onboarding a client, a portfolio manager will ensure that the client has understood the fee structure and charges. The new client has to separately sign the annexure on fees and charges and add a note that they have understood the fee details in the following manner:

As per new SEBI regulations, the portfolio managers has to provide a fee calculation tool to all clients that highlights various fee options with multi-year fee calculations. The fee calculation tool should incorporate the high-watermark principle wherever applicable. The link to access the said tool will be provided in advance to all new clients onboarded on or after October 1, 2024, by the PMS providers

Additional fee disclosures

In partial modification to the master circular, whenever performance fees are charged to the client, the annexure for fees and charges to the portfolio management service-client agreement will also contain the following additional fee disclosure:

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FAQ

Q. Where can I track the performance of all India PMS providers ?

Answer :

https://www.apmiindia.org/apmi/welcomeiaperformance.htm?action=PMSmenu

Q : What is high-watermark principle ?

Answer : A high-water mark is the minimum level that a fund manager needs to achieve to receive a performance bonus. The high-water mark clause protects investors by avoiding paying the performance fee for the same part of return when an investment fund or account recovers from the previous loss.

Q : Can you show an example of high-watermark principle in practical terms ?

Answer :

Let’s assume an investment fund charges a 2% management fee and a 20% performance fee annually, which are typical industry rates. An investor invested $100,000 into the fund, which generated a return of 10% in Year 1, -3% in Year 2, and 20% in Year 3.

In the first scenario, there is no high-water mark clause for the performance fee. For Year 1, the management fee is $2,000 (2% * $100,000), and the performance fee is also $2,000 [($100,000 * 10% * 20%]. The AUM at the end of Year 1 is $106,000 ($110,000 – $4,000), which gives the investor a net return of 6%.

For Year 2, since the fund experienced a loss, there is no performance fee, but a management fee of $2,120 (2% * $106,000) is still charged, which gives an ending value of the fund worth $100,700 [$106,000 * (1-3%) – $2120].

For Year 3, the value of the fund reaches $120,840 [$100,700 * (1+20%)] before the management fee. After paying a management fee of $2,417 and a performance fee of $4,028 [($120,840 – $100,700) * 20%], the investor’s net return for this year is 13.6% [($120,840 – $100,700 – $2,417 – $4,028) / $100,700].

In the second scenario, let’s assume that the high-water mark limits the performance fee. The management fees are not impacted by this clause, and the performance fees for the first two years remain the same as the first scenario.

The fund reaches a high-water market of $110,000 ($10,000 * 10%) at the end of Year 1, which limits the third-year performance fee to the return above this level, which is $10,840 ($120,840 – $110,000). For Year 3 the performance fee is $2,168 ($10,840 * 20%), and the investor’s net return is 15.4% [($120,840 – $2,417 – $2,168 – $100,700) / $100,700].

Comparing the two scenarios, the high-water mark prevents the investor from paying for the $9,300 return again in Year 3, which was achieved and charged in Year 1 but partially lost in Year 2. The investor, who is protected by a high-water mark, will be able to pay a lower amount of performance fee and earn a higher net return.

Article source : SEBI Regulatory announcement

Article Editorial : Abhinesh Kumar, Business Coach and Mentor, ARM Fintech Consultants (P) Ltd

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