The fee structure is one of the most critical aspects of any portfolio management arrangement. SEBI (Portfolio Managers) Regulations, 2020 provides clear guidance on what fees portfolio managers can charge and how they must be structured. This article explains the different fee models, regulatory requirements, and compliance obligations.
Regulatory Framework for PMS Fees
Legal Basis
Regulation 22(11) of the SEBI (Portfolio Managers) Regulations, 2020 provides that the portfolio manager shall charge an agreed fee from the clients for rendering portfolio management services without guaranteeing or assuring, either directly or indirectly, any return. The fee so charged may be a fixed fee or a return based fee or a combination of both.
No Upfront Fees
A critical prohibition under the regulations is that no upfront fees shall be charged by the portfolio manager directly or indirectly to the clients. This ensures that fees are aligned with the actual delivery of services and prevents portfolio managers from collecting fees before providing any value.
Operating Expense Cap
Operating expenses excluding brokerage, over and above the fees charged for portfolio management service, shall not exceed 0.50% per annum of the client's average daily Assets under Management (AUM). This cap ensures that clients are not burdened with excessive operational costs.
Types of Fee Structures
Fixed Management Fee
A fixed management fee is a percentage of the assets under management charged on a regular basis, typically quarterly or annually.
Key Characteristics:
- Charged as a percentage of AUM
- Typically ranges from 1% to 2.5% per annum
- Charged regardless of portfolio performance
- Provides predictable revenue for the portfolio manager
Regulatory Considerations:
- The fee must be disclosed in the agreement
- Must be calculated on the actual amount of clients' assets under management
- Cannot be charged as an upfront fee
Performance-Based Fee (Profit-Sharing)
A performance-based fee is charged based on the returns generated by the portfolio manager.
Key Characteristics:
- Charged only when the portfolio generates positive returns
- Typically a percentage of profits above a specified threshold
- Aligns the interests of the portfolio manager with the client
Regulatory Requirements:
- Performance fees must be calculated based on the high water mark principle
- The frequency of charging performance fees shall not be less than quarterly
- Performance fees can only be charged on increase in portfolio value in excess of the previously achieved high water mark
Hybrid Model
A hybrid model combines both fixed and performance-based fees. This is the most common structure in the PMS industry.
Key Characteristics:
- Fixed fee provides predictable revenue
- Performance fee aligns interests
- Typically includes a lower fixed fee with a performance component
Regulatory Considerations:
- Both components must be disclosed in the agreement
- Performance component must comply with high water mark requirements
- Fixed component must be reasonable and disclosed
High Water Mark Principle
What is High Water Mark?
High Water Mark shall be the highest value that the portfolio/account has reached. Value of the portfolio for computation of high watermark shall be taken to be the value on the date when performance fees are charged.
How It Works
The portfolio manager shall charge performance based fee only on increase in portfolio value in excess of the previously achieved high water mark.
Illustration:
- Client's initial contribution: ₹10,00,000
- Year 1: Portfolio rises to ₹12,00,000 → Performance fee payable on ₹2,00,000
- Year 2: Portfolio drops to ₹11,00,000 → No performance fee payable
- Year 3: Portfolio rises to ₹13,00,000 → Performance fee payable only on ₹1,00,000 (excess over previous high water mark of ₹12,00,000)
Applicability
High Water Mark shall be applicable for discretionary and non-discretionary services and not for advisory services.
Interim Contributions/Withdrawals
In case of interim contributions/withdrawals by clients, performance fees may be charged after appropriately adjusting the high water mark on proportionate basis.
Fee Disclosure Requirements
Annexure on Fees and Charges
The client agreement shall contain a separate annexure which shall list all fees and charges payable to the portfolio manager. The annexure shall contain details of levy of all applicable charges on a sample portfolio.
Fee Illustration
Portfolio managers must provide fee illustrations covering:
- One year and multi-year fee calculations
- Different scenarios: increase in portfolio value, decrease, and unchanged
- High watermark principle incorporated where applicable
Fee Calculation Tool
Portfolio managers shall provide a fee calculation tool to all clients that highlights various fee options with multi-year fee calculations. The link to access the said tool shall be provided in advance to all new clients on-boarded on or after October 1, 2024.
Expert Legal Guidance
Anuj Desai & Associates provides expert legal advisory services on PMS fee structuring and compliance. Our securities law experts help portfolio managers design compliant fee structures, draft appropriate agreements, and ensure regulatory compliance. Contact us for guidance on fee structures and other regulatory matters.