SEBI Rules on Portfolio Management System and Impact on Stakeholders

Overview of Portfolio Management System

When an individual investor or company has a sufficient amount of investment, the individual or company would consider investing it in some areas. The motive behind the investment is to maximize profits and the rate of return on the investment. The individual investor would want to get the maximum benefits from the investment. The sum of the investment would be invested in a portfolio comprising of shares, securities, bonds, and mutual funds. Therefore a portfolio is considered as a combination or cluster of different tools related to investment. This portfolio would comprise of shares, securities, mutual funds, and bonds which provide a different rate of returns on investment.

A portfolio is a combination of the above securities, which provide a maximum rate of return on the investment. An individual would want to consider investing in the portfolio for securing the maximum about of return.  The portfolio of securities would depend on the amount of income that is earned by the individual investor. It would also depend on the amount of risk that is taken in the market, the market size, and other factors.

Portfolio Management System- SEBI Portfolio Management System

A portfolio management system is a process and procedure for making investment decisions for a particular investment in a portfolio of securities.  The portfolio management system is done by portfolio and asset managers. This system has been considered as the management of assets by a portfolio manager. Managing assets would comprise of the following:

1. Having an initial contract or agreement with the investor and the portfolio manager;
2. The terms of the agreement between the investor and portfolio manager;
3. Any form of fee arrangement that is present between the investor and the manager;
4. Assets that are allocated to individuals that become a part of the portfolio;
5. Calculating and assessing the amount of risk that the assets pose for the investor;
6. Ensuring that there is sufficient compliance and monitoring; and
7. Ensuring that portfolio managers protect sensitive data of investors.

The above process would apply to a system of portfolio management. Portfolio management can be understood as the process of managing individuals’ investments in securities. The securities would comprise of mutual funds, shares, stocks, bonds, and debentures. The type of investment would be taken into consideration for portfolio management. When accessing the amount of returns that would be expected from a proper system of portfolio management, the following factors are followed:

SWOT Analysis (Strengths, Weaknesses, Opportunities and Threats)

• Strengths- One of the main objectives of active portfolio management is to identify and access the advantages of a particular portfolio. Apart from this, the portfolio manager would consider the available income of the investors. This is regarded as one of the preliminary stages of portfolio management. 
  
• Weaknesses- The manager also considers the weakness of a particular portfolio. A prudent manager would not suggest a weak portfolio. Therefore determining the strengths and weaknesses of a specific portfolio is one of the main responsibilities of a portfolio manager.
  
• Opportunities- In this part of portfolio management, the portfolio manager would consider the type of opportunities available to the investor.  If a particular portfolio has the potential opportunity to secure more amount of investment, then the manager would recommend the investor to consider that portfolio.

• Threats- With a new form of opportunity, there would also be risks present with the portfolio. Every portfolio manager must explain the risks and threats which pose a danger to the investor. Usually, when it comes to advertising and promotions, portfolio management companies would demonstrate the potential impact of the investor. For example, a portfolio management company that is dealing in the business of mutual funds has to explain the amount of risks that are present in the investment opportunity to the investor. If the mutual fund company is promoting advertisements, then there would be a disclaimer effectually stating that market risks are present when an investor considers the opportunity of investing in mutual funds.

One of the main threats of the portfolio is market-related risks. Market activities are always volatile and depend on various factors.  These factors can, directly and indirectly, affect the market in multiple ways. Therefore a portfolio manager has to keep the threats in mind before explaining the investment opportunity to an investor.

The Securities Exchange Board of India (SEBI) is the regulatory body for managing portfolio management systems in India. SEBI portfolio management system has established a framework ever since it was introduced in 1992. SEBI portfolio management system regulations have come out intending to manage portfolio managers and ensure that they act in the best interests of the investors. The first portfolio management regulations were brought out in 1993. This is considered as the SEBI (Portfolio Managers) Regulations, 1993.  These regulations were related to registration, management, and governance of portfolio managers across the country. Due to various mismanagements and corporate governance frauds in the past, these regulations have been amended from time to time to come in line with the SEBI Portfolio Management system adopted by companies recently.

Karvy Securities Mismanagement

Mismanagement of funds was present in Karvy Securities Limited. The portfolio management company, without the consent of the investors, took shares from their Demat accounts. These shares were transferred to the Demat account, which was used by Karvy. After this, the shares were pledged with the bank for money. This money was transferred to another subsidiary of Karvy. In light of the above reasons, transparency is a requirement when it comes to Portfolio Management Systems.

SEBI portfolio management system ensures that this framework is obtained by having an efficient method of corporate governance in place.  Due to such mismanagement of funds, there was a requirement to bring out stringent regulations related to the SEBI Portfolio Management System. The SEBI portfolio management system is used by firms that are registered as portfolio managers. These companies have to comply with the laws related to the SEBI portfolio management system. SEBI portfolio management system ensures that the interest of investors is maintained.

A portfolio can be managed according to the requirements of the investor. Therefore the portfolio management company has to be compliant with the SEBI portfolio management regulations. The SEBI Portfolio Management Regulations define the meaning of a portfolio manager as a corporate body who has some form of agreement with the investor and provides consulting services either directly or indirectly. Consulting services here also involves management of the portfolio.

The various types of portfolio management under the SEBI portfolio management system are:

• Discretionary Portfolio Management- The investors here consider the advice from professional portfolio managers. Investors having no information regarding the management of securities would opt for this form of portfolio management. The Portfolio manager would maintain the portfolio of funds according to the requirements of the client.

• Non Discretionary Portfolio Management- There is no control or discretion by the portfolio manager in managing this form of Portfolio Management System. The manager would manage the funds according to the requirements of the investors.

Objectives of SEBI Portfolio Management System

• Investment would be catered according to the needs of the client– The client can opt for discretionary portfolio management or non-discretionary portfolio management. Therefore the investor is the decision-maker behind handling investments in an effective way to maximize profits.
• Gateway to investment options- Through an effective system of portfolio management, the investor would get an opportunity to choose from various portfolio management options. The investor can access the strengths, weaknesses, opportunities, and threats through this system. Through this system, an informed decision can be made by the investor.

• Experience and Skill- Portfolio Managers would be qualified in handling risks and making decisions. Therefore by considering the process of portfolio management, the portfolio would be handled by experienced professionals, thus reducing the risk.

• Liquidity- One of the main aims of portfolio management is to improve the amount of return from the investment. By investing in a portfolio of different securities, the investor would get the option to obtain liquidity from various sources of funds. Consider taking an example of an investor who engages a portfolio manager to invest a certain amount in a portfolio comprising of shares, securities, real estate, and bonds. Depending on the market performance, the portfolio would provide continuous liquidity to the investor from different sources.

• Reduction of Tax- Certain investors can reduce the amount of tax through active portfolio management. 

Therefore SEBI Portfolio Management System portrays the above objectives of managing a portfolio.

SEBI Portfolio Management System- Guidelines for Portfolio Managers

To establish governance and transparency, SEBI has brought out specific guidelines related to the management of portfolio by portfolio managers. These guidelines have taken considerations of the past activities of mismanagement of funds by portfolio managers. The guidelines specify the following:

• The guidelines are issued based on the Securities and Exchange Board of India (Portfolio Managers) Regulations, 2020 (‘2020 Regulations’).
• Specifications regarding the eligibility to act as a portfolio manager can only be through the board.
• There are specific eligibility criteria as per Schedule II of the  Securities and Exchange Board of India (Intermediaries) Regulations, 2008
• To be registered as a portfolio manager the manager should have a net worth of Rs. 5 Crore and this amount must be present from three years of commencement of the business of portfolio management.
• SEBI Portfolio Management System has been brought out based on the 2020 regulations related to portfolio management.

Payment of Fees (SEBI Portfolio Management System)

• Regulation 22(11) of the 2020 regulations do not require a fee to be paid to the portfolio manager. This fee should not be charged either directly or indirectly from the client.
• Brokerage fees which would be charged to the client. This would be considered as expenses.
• Other fees such as operating fees apart from the service fee should not be more than 0.50% per annum for the Investor/ Client Assets under Management (AUM)
• If the portfolio of the investor or client is redeemed in full or par, then the following exit load would be charged:
  • 1^st year – up to 3% is charged as exit load;
  • 2^nd year – up to 2% is charged as exit load;
  • 3^rd year- up to 1% is charged as exit load; and
  • 4^th year- No form of exit load is charged on the redemption for the 4^th year.
• Brokering Charges should be capped to a maximum of 20% as per the value related to the associate

Requirements for Direct onboarding (SEBI Portfolio Management System)

• The portfolio manager would provide consulting services through direct onboarding.
• All the information on disclosure documents have to be published in the website regarding the direct process of onboarding.
• No charges should be added when onboarding.

Marketing/ Promotion for Investment Approach (SEBI Portfolio Management System)

• All particulars related to investment must be the same across websites, regulatory documents, client documents, disclosure documents, and marketing materials.
• Descriptive information on the investment approach related to the portfolio management company should contain the following:
  • Objectives/ Goals related to Investment;
  • Types of securities that are present in the portfolio- whether the securities debt listed or equity listed or convertible instruments;
  • Basis of selection of the securities;
  • Portfolios which are offered across different types of investments;
  • Market risks associated with the investments; and
  • Tenure or period of the investment.

Corporate governance reporting (SEBI Portfolio Management System)

• In compliance with proper standards of corporate governance and reporting, portfolio managers/portfolio companies have to report to the SEBI one a year or twice a year.
• Portfolio managers to be compliance with Corporate Governance reporting have to submit the following:
• Certificate from Qualified Chartered Accountant – the net worth of the portfolio manager as of 31 March every year based on accounts which are audited within six months from the end of the financial year.
• Compliance Certificate regarding the SEBI Portfolio Management System and SEBI Portfolio Management Regulations. This has to be signed by the principal officer within 60 days of each financial year. Any form of actions related to correction have to be brought out in this report
• Every portfolio manager has to submit a monthly report regarding the portfolio management activity. This must be submitted on the online SEBI Intermediaries within seven working days before the end of every month.
• Apart from the above, a report has to be furnished by the Portfolio Managers every quarter.

Performance of Managers (SEBI portfolio Management system)

According to Regulation 22(4) e, the performance reports of portfolio managers have to have the following:

• Performance is based on the actual cash holdings and the liquid funds. For understanding the performance of a portfolio manager, all the above has to be considered.
• All fees and expenses have to be reported.
• If there is any alteration in the investment approach, which would directly or indirectly affect the portfolio of the client. This change must also be brought out in the marketing material.
• Performance report which is submitted to SEBI must be the same which is mentioned in the marketing material and the website of the portfolio manager.
• The aggregate performance should be the same as the total performance of the portfolio manager.
• A disclaimer has to be provided that SEBI does not verify the marketing information.

The above requirements have to be complied with and reported to SEBI within 60 days at the end of each financial year.

Director or Partners of the portfolio manager has to verify and certify the report.

Material Adverse Change (Disclosure Documents) (Regulation 22(7))

If there is any form of change in the structure of the portfolio manager or material change, then this must be reported to SEBI. The following would be considered to apply as a material Change:

• Change of Portfolio;
• Change in Directors;
• Services Includes; and
• Change in Fees.

The above changes are material changes according to SEBI Portfolio Management System.

Monitoring Distributors- SEBI Portfolio Management System Regulation 23(10)

• Services of famous distributors have to be used. The valid distributors should have a valid AMFI (Association of Mutual Funds in India) Number.
• The expenses such as fees and commission must be paid to the distributors on a trial basis.
• Any fee or expense that is paid to the distributor must be informed to the client/ investor.
• Ensure that distributors are compliant with the code of conduct.
• Self-certification has to be provided by distributors at the end of 15 days.

Impact of the SEBI Guidelines on Portfolio Managers

These guidelines were brought out to increase the amount of corporate governance norms and reporting standards. The new rules of the SEBI portfolio management system ensure there is transparency between the investors and the managers. Portfolio managers are not allowed to charge fees to the clients, but the only amount that can be charged to clients are the operating expenses. In the wake of the new guidelines and rules, the managers would not be affected as most of the investors who invest in portfolio are high net individuals. Though these rules and guidelines would impact the profitability of the portfolio manager, still the motive behind bringing out the law was to improve transparency in the portfolio management system. Through the SEBI Portfolio Management System an effective framework can be maintained.

Conclusion for SEBI Portfolio Management System

Portfolio management is a process in which companies manage a pool of investments. This pool of investments is called a portfolio. The portfolio would normally comprise of securities such as shares, bonds, debentures and other securities. To effectively manage a portfolio for an investor, a manager has to use the SWOT analysis. Through the above an investment can be matched to the correct portfolio. SEBI portfolio management system has a set framework of guidelines which portfolio managers across India follow. The SEBI portfolio management system ensures that there is a proper framework for corporate governance established in portfolio managers firms. This is due to the mismanagement of funds by Karya Securities.  By using the SEBI portfolio management system, the standards of reporting and governance have improved.