Model portfolios are an important aspect of portfolio management services. This article explains what model portfolios are, their risk disclosure requirements, and audit obligations.
What is a Model Portfolio?
Definition
A model portfolio is a basket of securities for which a research report is issued by a research analyst recommending the relevant weightages for one or more securities mentioned therein. In the context of PMS, a model portfolio represents a pre-defined investment strategy or approach.
Key Characteristics
- Pre-defined investment strategy
- Specified weightages for securities
- Based on documented investment philosophy
- Used as a template for client portfolios
Model Portfolio in PMS
The portfolio manager curates a unique focused portfolio (usually 10-12 stocks) for each client based on the timing and quantum of his/her investments.
Regulatory Framework
Investment Approach
An Investment Approach is the documented investment philosophy adopted by the portfolio manager while managing the client's funds in order to achieve client's investment objectives.
Model Portfolio Restrictions
The portfolio managers in India are not allowed to disclose any model portfolio returns or the performance of one or more cherry-picked portfolios in any communication.
Risk Disclosures
General Risks
Model portfolios are subject to:
- Market risks
- Concentration risks
- Liquidity risks
- Sector-specific risks
Investment Approach Risks
The investment approach must disclose:
- Risks associated with the investment approach
- Risk factors specific to the strategy
- Market risks applicable to the securities
Disclosure Requirements
Portfolio managers must disclose:
- The investment approach in the Disclosure Document
- Risks associated with each investment approach
- Performance of the investment approach
Audit Requirements
Performance Validation
Model portfolios must undergo performance validation.
Benchmarking
Model portfolios must be benchmarked to relevant indices.
Facts heet
Model portfolios must be accompanied by a detailed factsheet outlining:
- Methodology
- Disclosures
- Investment horizon
Annual Audit
Model portfolio performance must be verified as part of the annual compliance audit.
Compliance Requirements
Uniform Nomenclature
The information about investment approaches offered by portfolio managers shall be uniform across all types of regulatory reporting, client reporting, disclosure document, marketing materials.
Description Requirements
Any description of investment approach must include:
- Investment objective
- Description of types of securities
- Basis of selection of securities
- Allocation across types of securities
- Appropriate benchmark
- Indicative tenure or investment horizon
- Risks associated
Prohibited Activities
Cherry-Picking
The performance of one or more cherry-picked investor(s) cannot be mentioned or implied in performance reporting or in any other communication.
Model Portfolio Returns
Model portfolio returns cannot be disclosed in any communication.
Expert Legal Guidance
Anuj Desai & Associates provides expert legal advisory services on model portfolio compliance for portfolio managers. Our securities law experts help clients define compliant investment approaches, disclose risks appropriately, and ensure regulatory compliance. Contact us for guidance on model portfolios and other regulatory matters.