EP39: Why we run a PMS and how we do it differentlyEP39: Why we run a PMS and how we do it differently

[podcast]

 

What is a Portfolio Management Service? How does it really work? Do they actually benefit their clients? In this episode, Vashistha and Deepak explore PMS' through their experience of running one at Capitalmind. They explain how the operations work, the pros and cons of different fee structures, quantitative strategies and how PMS' are different from AIFs, Mutual Funds and Smallcases.

Summary:

• 0:02:30: Long journey from being broke to managing+advising on Rs 1,500 crores (200 million USD) - but is there still more money in Options Workshops?
• 0:03:40: Evolution from DIY (Capitalmind Premium) to DIFM (Capitalmind Wealth PMS)
• 0:04:50: Precursors to the PMS Momentum Portfolio, looking at charts, outliers as a concept, ranking, filters
• 0:11:00 How Dare You Buy at All Time Highs? You need to buy at All Time Lows!!
• 0:12:00 Market was wilder in 2007 than today
• 0:13:30 Strong Stock Portfolio shortly after Demonitization
• 0:15:30 Customers - These ideas are great but can’t you do this for me?
• 0:18:20 Discretionary PMS and a Manager who decides what to do
• 0:19:25 Advisory - you tell me and then I’ll do it
• 0:21:25 All PMS were in the Extreme Risk bandwagon, sometimes the risk wouldn’t work like in 2016/17
• 0:22:30 Needed some help with overall planning or asset allocation, created Goals like Retirement, Kids Education
• 0:26:00 Plan Tool to visualize these calculations, inputs to this flow into the BackOffice System and Tech. Backoffice is a full system that manages the deployment, reacts to the market, and maintains the asset allocation.
• 0:31:00 Don’t Buy Everything on Day One
• 0:33:50 SIP model in PMS, No distributors and Direct to Customers
• 0:37:00 No Profit Share, lower cost approach to meet customers, our PMS starts at 0.25% up till 100bps i.e., 1% for the active strategies
• 0:39:00 Where’s your skin in the game?
• 0:46:45 Outsourcing Discipline, stock goes up 30%, someone books a profit and the stock keeps going up - now what?
• 0:50:50 Benefits of Deepak investing through PMS vs. directly on his own before this
• 0:54:00 Mutual Fund executes immediately (bound by rules) and differences between MF and PMS, at one point the Momentum PMS was 80% cash, tax efficiency of MFs, TER in MF does not include STT - you don’t get an invoice from them, STTs and Tracking Errors, True Expense Ratio
• 1:05:30 What Portfolios do we offer and how has this evolved over time? Consistent vs on trick pony.
• 1:12:00 Declining outperformance in mutual funds, foreign growth and the genesis of the Market Index Portfolio in 2019, Buying 1 lakh units from Motilal Oswal directly
• 1:16:00 Launch of Momentum in 2019, Intuitive in other areas like sports. Positive feedback loop on the way up. Negative spiral on the way down. Doesn’t look for narrative or reasons.
• 1:25:30 Goals, Mix and match of Portfolios - personalize to customer
• 1:27:30 Preserve - tax efficient way of conservative investing into Equity where only the growth of your debt funds gets moved into equity. (Internally we call it Don’t Lose Money). Risk appropriate way of investing.
• 1:31:00 NAV of all your Portfolios as a whole, Look at your Portfolio as a whole rather than just the individual pieces
• 1:34:00 Scaling in (like an STP and SIP) and Allocation
• 1:36:00 How PMS Operations work in general - custodian, bank+trading account per client or 1 custodial bank account + individual demat accounts
• 1:47:50 Exiting or Partial Withdrawal from PMS
• 1:50:00 Fun of filling Forms, 1 week to open the account and 1 week to exit
• 1:54:30 Players involved - ICICI Bank as Custodian, Creating a New Demat Account, When our First Custodian went Bankrupt, Depository is NSDL/CDSL - the giant ledgers. Broker is Zerodha. MF Utilities through Custodian for Mutual Fund Purchases. RTA like CAMS or K Fintech to confirm the transactions.
• 02:05:00 Why you’ll see cash every now and then in your account, how taxes work, audited statements
• 02:16:30 Where Smallcases fit in, planning your execution with market orders, cash drags
• 02:22:00 AIFs and taxes, business income, long short AIFs vs. the Nifty,
• 02:28:45 Biggest Value Add of using our PMS - discipline, low cost PMS, better than doing it on your own

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Full Transcript

Deepak Shenoy: Welcome to Episode 39 of the Capital Mind Podcast. This is Vashistha Iyer and Deepak Shenoy at Capitalmind speaking about an interesting thing that we wanted to talk about a lot, largely because we get so many questions about it. What is a portfolio management service, also known as a PMS?

To people not in the financial field this may sound strange, but the word PMS here actually actually means somebody who manages your money for you and we've brought together an entire episode to talk about the various aspects of a portfolio management service. And as disclosure of course, Capitalmind is registered as a portfolio manager and runs a Capitalmind Wealth PMS, where we manage about 450 plus crores (currently 520) in assets. And our learnings will come through in this entire podcast.

Welcome Vashistha.

Vashistha Iyer: Hey Deepak, we did a podcast in 2019 about cash flows and managing them and so on. There was a quote in that podcast which became very popular on Twitter because our guys kept tweeting it out again and again, where you said that at the age of 30 you were bankrupt?

So, from being bankrupt to managing 450 plus crores in AUM and about a thousand plus crores in an AUA, it's been quite the journey. We were joking the other day in the office that the whole game nowadays seems to be, you know, intraday option selling and training around options.

I remember in 2016 when I just joined Capitalmind and moved to Bangalore, we had around two months of payroll left in the bank, and we also did an options workshop. But you know that was more conservative. It was not as fancy back then. We were just joking the other day that maybe if we had just continued doing these (options workshops) it would be more profitable than running a PMS!

Deepak: The only problem with that is it has a shelf life. And hopefully this one doesn't, but I mean you're right. In the end, it is about what makes money. Sometimes, the giving of knowledge has more money in it.

Vashistha: But in a sense, by building this PMS over the last four years, what we have done is basically graduated from giving gyan on how to do things, to doing and managing money. And we've learned so many different things and you know, it's a completely different ball game. And that's what we're going to discuss in this episode i.e how is it? Why did we start a PMS and why do we run it the way we do it? and so on. So, let's go back to the genesis of this right.

You started Capitalmind out as a blog, yes? And then you added Premium. Your hypothesis was people will pay to read what you write and just walk us through. How did that move from the DIY model to you know managing people's money?

Deepak: Yeah, you know when we started off, my thought was if I can get 100 people to pay for what I write then there is a model here. This is 2013 when if you told folks that people )in India?) would pay for content, they'd be like are you out of your mind. And I got that and we talked to a few VCs. They said listen, this is not a fundable model (and not that I needed funding at that time). But I was more like I want to try this out.

But from there I discovered over the years and the first few years were very complicated because the issue really was, we started off saying, OK, let's do research. You can't do pure research because people are saying, what do I do with this research? Well, you can buy stocks because there's real value in looking at data and analyzing stuff. Some analysis can be purely quantitative, some of it can be partly qualitative, plus quantitative.

And then we can buy stocks. We build a portfolio of them. The initial set of portfolios were primarily around momentum, around the technical concept of stocks breaking out showing great moves and were also reasonably interesting, fundamentally. We start building that portfolio saying, listen, we’ve great opportunities for the short term and then we've got great opportunities for the long terms. There's a long-term portfolio and there is a short-term portfolio. In fact, that was how it started off, until it morphed further.

Vashistha: It was called the momentum portfolio.

Deepak: Yeah, it was called momentum.

Vashistha: That was you looking at charts.

Deepak: Yes, that was me looking at charts. At that time, one of the things that I wanted to build at that time was the ability for anyone to be able to look at data and automatically select their own stocks, so we built SNAP, the beginning part of it with another concept called the Outliers. Now the outliers are very interesting because the idea was, I could tell you which stock is making a new high. I could tell you which set of stocks are making a say, a moving average crossover or whatever it is.

There are a bunch of technical criteria where you can see uptrends and downtrends. But what if I ranked all the stocks based on the strength of how strong or how many such indicators worked in that favor? You would get the strongest stocks with the highest rating and the weakest stocks were the rest. So, the outlier concept was that anything that was out of the ordinary is of interest to you.

You don't care if a stock goes up 1%. You care if a stock goes up 10% but there's so many stocks that you can't keep mapping and looking at all of them. So, we brought together a tool that said we could look at the universe and highlight the most outliers in terms of price or volume momentum.

The idea here was that people would look at these things and discover their own stocks. So, we just put it out. We soon discovered that this is great, but people wanted help. They were saying, ‘listen. I'm looking at this. I want validation. I want you to tell me that this is okay to buy because there's a lot of weird, strange stocks’, because if you're looking at something quantitatively, you'll get some Rs. 2 stocks becoming Rs. 2.50 paise also. But those are not stocks you want to buy, and I thought that was obvious. But people said no, no, no. It's not obvious and you need to kind of filter this down for us. So, we said, OK, let's fill built-in filters. We said large cap filters, midcap filters. We added a lot of layers onto the outliers. But part of the process of doing so was also listening. Let me show you how it works. Let's build a portfolio from these outliers.

That became momentum. I would manually look at each stock, which was a higher outlier and say OK, this qualifies. Let me let us go and buy this. Sometimes the outliers were strange because you didn't know why they were moving. Very boring stocks. Sometimes they didn't have any fundamentals. But they're moving.

Suddenly you find that after some time after they moved, they would start showing some signs of news. Oh, this new product has been launched or some acquisition has been done? And so on. The idea was that how does the market know this already? The answer is obviously that somebody knew, and perhaps they started buying a little bit early, but however it was, the idea was to focus on telling people what to do so they could. They could do it themselves.

I firmly believe that people will look at stocks independently from their mutual funds. After a while we discovered that one more part of the world, which is the fixed income world, is dominated by mutual funds because you can't do it yourself. Plus, it's not tax efficient, so we built a fixed income portfolio. So now we have a momentum portfolio, a long-term portfolio, a fixed income portfolio and we're thinking of this a little more. Through this process, it suddenly became that why am I looking at charts every time. Long term, I understand, you know.

I remember you asking why we are looking at charts every time I'm adding some 10 stocks and removing something. My background is also algorithmic trading, so I've used data. I've used algorithms, I have written them, to analyze stocks and then come back with specific things and all of us were in that same kind of tune. We're a motley crew of people who aren't from the financial world.

Shray is probably the only guy even qualified to say he's from some financial world, but otherwise all of us are not from finance as a background. Because we came in new, we didn't have to rely on things like, do I know the promoter? Do I know the founder? Do I know anything about the company that other people don't know? We were like no, we want to know what everybody knows and because we are so sure that people are ignoring the obvious that we could just write quantitative tools to look at and analyze the market.

Vashistha: And this is back in 2016 or so, right? This is before momentum became popular as it is today.

Deepak: Yeah, in fact I remember writing about momentum as a concept. Now I don't call it that, but in 2007-2008. So, 2007 was when I wrote my first set of algorithms as part of an earlier start up called Money Yoga where we are trying to discover stocks making new all-time highs. There was an interesting start up in the US at the time called StockTwits and they had a video a week. This was before video became popular.

Vashistha: Oh, they're now in India by the way.

Deepak: This is very interesting. What they did at the time, and they were sold to CBS a few months after they were born is that they would identify a stock making an all-time high and prepare a small fundamental and technical thesis on the stock, which was often funny as well, because many of these stocks were funny. You just start writing about them and you know that you know there's something that happened.

What excited me about the fact was that they were only looking at all-time highs. In 2007, if you told people you are buying stocks at all-time highs in India, they would say you are a doofus. You should buy stocks at all-time lows, not at all-time highs. I mean, how dare you do that kind of a thing.

OK, because it was so new.

There was a tribe in Bombay, and I had moved to Bombay at the time and there was this trading tribe. The concept was created by Ed Seykota, who's famous for being interviewed in the Market Wizards by Jack Schwager and has generated a phenomenal return over years. A purely quantitative person in terms of programming and who looked at trends and commodities and made a lot of money there.

So, we were trying to apply this in stocks and there's this trading tribe in India who were probably the only one in India at the time and I joined them and again here is one place where people were not embarrassed to buy at all-time highs.

Some of the people from that group are now quite famous in terms of trading philosophies and trading itself. But what was interesting was this was one place where you didn't have a problem (with all-time highs), and if you talk to traders, their time frame was hours, and you know maybe one or two days.

2007 was wilder than the market is today. I think 1.5 X that was what it is today, because that time you could see stocks walk into the market and walk out with a 5% gain in like 15 minutes and you're done. 

The 5% gain at that time was significant. Even now it is. It's like a more than a year’s return in a liquid fund. But if you look at something like that, momentum was what traders did and value and buying at lows was what investors did.

But I was really sure even that time it didn't matter if you were a trader or investor; those all-time highs are always an indication of a good trading strategy and sometimes (you obviously wouldn't be right all the time) you discover a few stocks that would give you 10X, 15X, 20X. We discovered a few of them at that time from 2007-2008, when we were building this process. But when we started off with Capitalmind, the underlying philosophy also was that this is a difference.

If you look at things quantitatively, you'll make a lot of money by simply looking at moves and trends in the market. The first few years were manually identifying those trends when you came in. I think the first thing that we did around this idea was in 2016, it was roughly around the demonetization time.

Vashistha: Yeah.

Deepak: In fact, just five days after demonetization. I remember we wrote a post saying we're selling everything and five days after that we said that we're starting something called a 30 strong stock portfolio. The idea was 30 stocks in momentum that we identified. The issue of selecting stocks manually is that it makes you want to keep some of those stocks when the market goes down (and in 2016 during the demonetization, the market had gone down). So, the idea was now to sell everything, start everything, clean.

Vashistha: In fact, when we released that portfolio, it was a market low.

Deepak: Literally yes, the low of the year (and more). It was quite remarkable that we were lucky enough to have got in at that time and remember in Twitter they said Deepak, you've sold everything you're not loyal to the country and whatever and all that.

We were like no. We sold everything but we bought everything right back. That does not prove you are loyal. We're just saying in this downturn, if some stock still shows strength, then they're worth buying, because if you're buying at the low point of the market and you are buying stocks at all-time highs or near all-time highs. So, if you are strong stocks in a weak market which tend to do well in six months, this stock portfolio had an absolute return of 24%, much more on the market which did about 10 to 12%.

So, we were like OK, there is something here. We ran the experiment six months just to see and we did another round and this time we called it a permanent-ish momentum portfolio.

Vashistha: And that's and that's only first said we'll have a frequently rebalanced portfolio. I mean on a schedule. We said every first Monday of every month is when we will rebalance this portfolio.

Deepak: And you know what started to happen? It happened that the returns were interesting, people got interested now. 2017 was another time of great madness…

Vashistha: Just to bring us back to the topic, otherwise, we'll keep going and on about momentum! This is the same time when we had applied to become a PMS.

Deepak: Yes, I think that by 2016 we are starting to realize something, even, when all this momentum and thought process was going on, is that our customers are telling us Deepak, this is all good. You guys have a great interesting philosophy and all that stuff. You're telling me to do this. Can't you do it for me?

I have written a post in 2011 or 12 which talked about creating a hedge fund in India where you could manage other people's money. Now, of all the things that we could do, the only legal thing that we could do is become a portfolio management service. We needed a 2 Cr net worth; we needed a few more things that were part of the process.

We had everything except the fact that we didn't know what we needed to do. I think we didn't have the two cr net worth at the time, but that was one way we said, OK, we could manage people's money.

So, we asked around and we said if we did manage your money, would you give it to us and the limit at that time was 25 Lakh rupees. You had to have a minimum of 25 lakhs to invest in a portfolio management service. And we said, OK, let's do this. Let's go apply to become a ‘we will do it for you’ service rather than we are telling you ‘what to do’ kind of service.

Vashistha: Let's break it down for a bit. PMS are three types. Three things you can do discretionary, non-discretionary and advisory, right?

Deepak: Yes, so let me tell you from another point of view. Let's say you wanted to manage somebody else's money. You could go to a friend and say give me your account username and password. But if you (because of SEBI rules) do this, you're illegally managing his money in the sense of you're saying you're doing something for a friend. If he doesn't complain to SEBI, you're OK. If he complains, it's possible that they could take some action against you because you're running what is called an illegal Portfolio Management Service.

Your broker could do this for you. So, he'll probably call you up and ask you, ‘I want you to buy this stock? Will you buy it? You say, yes. Sir, can I punch the order for you? and you will say yes and then he'll punch the order. In a way, he's getting a confirmation before every trade from you. This is also technically a managed service, but brokers do it often and SEBI doesn’t take any action on these kinds of things.

But SEBI has in the recent past said, listen, people have complained that you have punched in an order without telling them. Do you have a recording of the call you've made? So now brokers have a recording of the call that they've made. So, the compliance has increased, but what is happening on the other side is also that SEBI said, listen, we have a mechanism where you can say I will buy or sell stocks for a customer. He or she will give me permission to do so, but I do not have to take confirmation. This is called a discretionary PMS where it's the manager's discretion to say how much she wants to buy, when he wants to buy, how much to buy?

So, there's a complete discretion of the manager. This discretion can also be said as, I will buy it, but I will get your confirmation first, so I will suggest what to buy. You will say, OK, and then only will I buy it now. Some people may have these rules that say, well, no, no you got to tell us what you're going to buy because you're using our money, so please tell us what it is and then only buy. So, the same PMS can have a discretionary strategy and non-discretionary strategy.

Obviously, the issue becomes some people will also say listen, why are you buying on my behalf? If you're telling me what to buy, I can buy it myself. This becomes an advisory where you only tell them what they're supposed to do. They go ahead and execute it on their own (or not). Or typically family offices who may have their own execution teams, might say I'll take four or five advisories and I will select all of them, which the best stocks are and execute them on my own.

Vashistha: Or you might want advice on how to structure a debt portfolio, correct? So, you can go to a portfolio manager and get advice on that.

Deepak: Yes.

Vashistha: You could come and say, I have all these 20 stocks. Can you advise which ones to keep? Which ones to pull and so?

Deepak: This is how the RIA concept came. At that time, it didn't exist, but the RIA concept is now allowing you to do something like this. Still, PMS is primarily for people who have more than the minimum of Rs 25 lakhs. So, we said, we'll do discretionary payments because essentially, that would give us the flexibility to be able to buy and sell whenever we want it.

Because imagine you scale and then you have many customers. Then you must call each one and ask them whether they should buy and sell and some of them say no, we'll get back to you. At which point you can't use technology right? Because now you are suddenly saying, oh, this guy hasn't given permission.

So don't buy for him, but another person has agreed, so buy for her and by the end of this game you're going to be like, you know we can't run a scalable strategy.

So, we started by saying, let's build a discretionary strategy. Let's try and do a few other things.

Vashistha: You mentioned technology here and did something different and we chose to do a goal-based approach for our clients, right? And which has evolved since then, as the minimum went up to 50 lacs. We have moved slowly from being entirely about goals-based to rules-based in terms of the strategies that we have, so let's discuss that for a bit.

Deepak: Yeah, that's so when we started off, we said OK, you could be another PMS, but can we just run on the Capitalmind brand and say oh, please invest money in us? The other problem that we realized was that the people who are giving money to PMS were largely going on this extreme risk bandwagon, which is I'll give you 25 Lakhs, just go crazy about it and you know, just invest it wherever you want, and it will make lots of money and all that stuff. And then the managers are expected to take a lot of risk. The managers would take a lot of risk and sometimes that approach would work ike in 2016.

But we said OK, this is a problem. Now if you give 25 Lacs to a person to take a lot of risks, that means you're already worth 1 Cr or two crores because that's the sort of person that can say take a lot of risk with the 25 Lacs. This automatically meant that people whose net worth was 30-40-50 lacs were completely left out of the picture. They were like, I'm not giving you 25 Lakhs to take this kind of risk, I mean, we're not going to do it. So how do you now balance that out with the fact that a lot of our customers were in that range?

They were telling us that listen, we are not going to risk it all in this way. Can we figure out a way that we can? We can do something in a less complicated manner, taking relatively stable amounts of risk. The second part of this was that we have already identified that people need help with their own personal financial planning in the sense that while you may have a lot of money, you may not be financially stable in the sense that your money is lying around in fixed deposits, which is inefficient. It's lying around there. There is money that is there, but it needs to get invested because otherwise you're not going to make your goals at the time you have children; you have to educate them. You know that their education costs are going to be high. You must plan to get to that point, and many of them were like, OK, 50 Lakhs is there. It's ok.

But when we pointed out that listen, 50 lakhs is nowhere near enough and you're going to have to build a corpus of nearly three or four crores in maybe 10 years in order for you to be able to A) retire B) plan your children's education and do all the other things that you think you can do, but you can't.

We built a concept around that thought process called goals. So, the idea was you compartmentalize your life into each different goal. Each different goal is one. For instance, retirement. And that retirement concept is, work because you want to, not because you must.

That means you're working simply because you love to work and the money that you have stored somewhere can generate enough money to meet your expenses for the rest of your life. This is effectively the feeling of retirement, which is what we wanted to start out and said listen - every person has a number, and that number is something and we can tell you how that number is reached.

Because if you're spending one lakh a month today, in 15 years, you're going to be spending two lakh rupees a month, just at 5% inflation. And if I calculate these 15-year slots till the time you tie, which is not the age of 90 or something like that. And I looked at it and said listen, for every year that you are increasing your spending, I am going to need a corpus big enough that generates enough returns so that it can both meet your needs. And sometimes you may have to eat from the corpus, but what's that corpus required so that at the age of 90 this corpus dwindles down to 0?

Assuming your expenses remain the same and increase with inflation every year, in the sense that you know if you're spending one lakh a month today, it's the same one lakh, which is adjusted for inflation going forward. We talked to a lot of people and then we help build models around this. So, we said OK, this is what you're going to need for retirement. This is what you're going to need for your children's education, because that's usually a big number. If you go to the US, for instance, your child will have to spend 35 lacs per year because about $50,000-$70,000 roughly per year in two-four years and then that amount we must adjust for inflation and rupee depreciation and all of that stuff.

So how do you find out what that number means when your child goes to school, which is about maybe nine years because the child is 9 years old today or 15 years if the child is 3 years old today.

Vashistha: There are calculators that have been around for a while, we also built one (visual) which made it easy for when we had these conversations with clients to explain their own financial situation to them.

Deepak: Which, in fact, I think the first set of things was a Google sheet. Yeah, and then you took this and then I remember when you came, you were mostly involved in options trading and your background was in design, but you took over the front end of the building of this technology and then you build what is and still is ‘Plan’ (https://plan.capitalmindwealth.com/), which is a planning tool that could automatically determine exactly how your life should go so it's not only that you need to reach 3 Cr, but also how much money do you need to invest in order to get there, how your trajectory or this glide path from now to then should be? Because it's an accelerating curve, so it's a parabola in an upward direction, if you may, but also because you expect that people will not just save on SIP of say, one lakh rupees a month. They might say, listen, your one lakh rupees a month today is not the same as one lakh rupees among ten years on the line, so it's obviously going to increase. I mean, it's going to be a larger amount because if I'm making X and I'm spending Y and X goes up by inflation, my expenses go up by inflation.

My savings will also go up with inflation, so technically I could have an increasing SIP, so all these calculations were built into that tool, and you still have it all in https://plan.capitalmindwealth.com/.

Vashistha: Yeah, you can go and play around, but that's not where we stop. We still use that, but that just flows into our back end as well and if we use that for deployment and managing how to balance your goals and asset allocation and so on.

Deepak: This is the brilliant part of I think where the effort starts off and continues.

Vashistha: Which also meant that we couldn't have used anything off the shelf. Most PMS in India use a software called Wealth Spectrum, right? And we had certain limitations because we wanted to do all these new things and that would have been a problem to do it in a third-party software.

Deepak: Yes, and we were one of the few people that were using debt. Because we were saying don't take so much risk, so when they said when people give us 25 lakhs, I was like no-no, not all of it in equity. Well, that's fine.

Let's do 60% in equity 40% index. Why are we doing this? The 60% in equity would give you the equity level returns 40% in debt, and that time that was giving reasonable returns. So, what we would do then that 40% would go into direct mutual funds. That again, was a specialty of ours so every other PMS that was doing this was not using direct. They were using regular mutual funds.

Vashistha: They can’t anymore.

Deepak: Yes. They can't anymore. SEBI changed the rule in 2020 and they can't anymore.

When we started off, we started using that, but the other interesting thing was that it was dynamic. It wasn't like I was going to do 60% debt equity, 40% each time. The idea was that if the 60% equity started to go up so much that it became 70% equity, your subsequent SIPs would get deployed towards the debt portion automatically and the system would determine every month whether we should deploy money more into equity or more into debt. We try to optimize for taxes as well, so it is a complex system.

We did it through technology that we built and wrote internally itself because no other tool was doing this. We saw at that time there were a bunch of US software companies like Wealthfront and Betterment and so on. They didn't have the deployment sophistication that we did, which means our entire deployment was automated to the extent that we would know exactly how much would go into equity. As a fund manager, I would design the portfolio, equity, and debt portfolios, and which mutual funds to invest in debt? Which equity stocks to buy as a model level, but for each person because they had a different amount of cash. Each person would say, well, you need to buy two stocks of this or five stocks or this for person A and six stocks of X and 10 stocks of Y. The technology built it together and throughout what we call a trade sheet.

So, the idea is the trader doesn't have to now say, OK, for this order person order by two for that person order by 7. That's not his concern. The trader just simply says buy 7 stocks; the system will allocate it automatically. And this is where I think the improvement in the technology right up front kept us on our toes because we had this goal-based system.

The goal-based system would flow in, and the system would do all its little magic inside and say, well, OK, this is the trade sheet you need to buy for equity, this is the trade sheet you need to buy for debt. For that, please go ahead and exit...

Vashistha: And then we would allocate to all clients and so on.

Deepak: Automatically, so yeah. The problem really was sometimes if the trade sheet said buy 100 shares of some company for person A, we wouldn't buy. We couldn't, sometimes by the hundred we could buy only 90 because of liquidity or something like that and the system would automatically adjust and say OK, well if you bought 90, that's fine. Just go ahead. So, we could literally do a daily purchase of stock. So, if I had to buy 100 by 10 on the first day, 20 on the second day, 30 on the 4th day. It would automatically allocate appropriately to each customer.

Vashistha: In fact, I remember the early set of customers demanded some of them. They demanded that. Look, I'll give you 50 lakhs or 55 lakhs, whatever. Don't go and buy everything on day one. Please give it some time. Buy it over a period, and that was a default behavior anyway, so it's very interesting.

Deepak: We started off in 2017 November. 2018 January is when the finance minister of the day introduced the budget in which long-term capital gains was taxed for the first time in 14 years. So, the market started to fall. A lot of people benefited because they were able to spread their investments over six months rather than all at once. But more importantly, we wanted to give comfort because anybody who is giving 25 lakhs at one shot, doesn't want to see that go down or go up or down too much.

Vashistha: And it's behavioral, right? It's like you can do a back test and analyze and it'll tell you that you know most of the time you should just deploy together (not do an SIP). You're better off eventually, but you know the first year. If you have a huge drawdown, you're going to get jittery, you can get scared.

Deepak: Yeah, it's in fact, even now I tell people the same thing if you ask me. Now I have a lump sum of 50 lacs. What should I do? Put it into a liquid fund, feed into an equity fund over a period of six months, you will feel so much better. It's simply behavioral. You may feel little pang of regret saying listen if I had invested all of it at one time would have gone up, but I think that pang of regret is much preferable to the regret you will feel if you put all the money at once and it had fallen 30%, so you optimize for regret.

So whichever regret is less is better off for you. Well, in the end, what matters is that you sleep well at night. We recognize that in the PMS one of the reasons why you want to sleep well is also saying that listen, I need 3 crores for my retirement. I don't want to worry about how I am getting there because we would show you on Plan and there was another tool called Progress which you also built in January 2018. One thing it did show you is that if you had these goals, it could show you exactly where you're supposed to be every single month from now till the point your goal is achieved.

So, at any month you could likely say, listen, you're supposed to be at 26 lacs, but you're at 27, so you're doing well, don't worry about it. If you don’t, it could be because of various factors. The market was bad and therefore you're not as much as you should be, or it could simply be that you haven't put an SIP in many times. You will forget to put an SIP. You're supposed to invest a certain amount of money every month.

And that was also something that differentiated us because most of the other PMS said give us 25 Lacs, then give us another 25 Lacs. Otherwise, don't talk to us. We were saying no, after your first 25, give us anything.

Vashistha: 10 thousand, 20 thousand.

Deepak: Yes because we can deploy it. SEBI cares about the 1st 25 lacs. It doesn't say that you must get increments of 25 lacs. SEBI wants us to help people reach their long-term goals.

Vashistha: It's supposed to be handled that way because PMS are supposed to be fiduciaries, right? You must take care and you know you're responsible for the decisions you make for the client.

Deepak: So yeah, in fact, what is important here is that you are investing on behalf of the customer. It is not a pooled investment, not like a mutual fund where you take the money and you say, well, you know what, I'll tell you how the overall pool has done. That is not the thing. With a PMS, you're the owner of that stock. You're the one who has the voting rights. You are the one who can go and complain that the management is not paying dividends or is paying itself too much.

The PMS manager is only a manager. He's not the owner of the stock and therefore somebody must take a little more care and little more personalization when they do it. Not typically they don't do it, they simply say, listen, trust us we manage money. I'll manage your money just like I manage everybody else and we're fine.

We're going a little bit further and saying we're going to help you reach your long-term goals, whatever that makes sense for you, rather than for everybody else.

Vashistha: So, we've reached this point now where we are managing 450 plus Cr in assets and about 1,000 Cr and under advice. And we've explained what both mean, and we've gotten here without using any distributors.

Deepak: Many PMSes don’t care about personalization or anything like that because they don't talk to the customer directly. They get somebody else to bring them in. And you know one of the things I think when we discussed this, we were going to go on this thing. Listen, we have an existing customer base, so we don't have to go use distributors because we know our customers.

Vashistha: And, also it was difficult like we were building the tech from scratch and then we have to build a distributor module as well because there the distributors own the relationship with the client and not the PMS per say. And you know, we do have to give them views about these. These are the clients you have brought. This is the fees that we've charged, this is your cut and so on.

Deepak: What increasingly was happening was the sophisticated people that were already our customers, they already said, listen, we know what you guys bring to the table. So, we want you to do this directly to us. There were more and more such people, and they were not being served by the other PMSes.

Vashistha: Yeah, we have not spent anything so far on marketing advertising, whatever everything comes from referrals or from you know, premium clients want to upgrade to a PMS. Sometimes they're both their PMS customers and their premium subscribers.

Deepak: And what's also interesting is or fascinating is that there's a sense of community inside of the PMS and inside of Premium as well, where we are very open about our investing philosophy. Many PMSes are very paranoid about their customers talking to each other. Oh, he will reveal my Portfolio. I don't have a problem because what are you going to do? You want to buy more of it. That means my portfolio prices go up fine. I mean, that's perfectly well, but you know this concept. I think that differentiates us as well as the price.

A portfolio manager in India is allowed to charge a percentage of profits as a fee. So, if I make 100% for you (turn 100 into 200), I'll not charge anything till your returns have crossed 10%. It's called a hurdle rate and then the remaining 90, so I will charge you 20% of that 90. I'll charge you 20% of profits. But I also charge you a management fee of 1-2% of the overall 100% that you were running it and then I'll also charge you an exit load, an entry fee, and a bunch of other fees as well. So, now you're looking at this and saying listen, this is a high fee model.

But if you're using technology in the kind of way that we can or we are, can we not reduce the fees quite substantially? We're not even using distributors because distributors take 50% typically. So, if we were to take the low-cost approach, we don't need distributors. We can go directly to customers. We can solve customer problems. We can then get fees down to 1% management fee and nothing else.

Vashistha: Our current range, by the way, starts at 25 basis points.

Deepak: 0.25% in fact.

Vashistha: For a sort of passive-ish strategy.

Deepak: Passive strategy and then all the way up to 100 basis points, which is 1% for an active strategy. This is probably the lowest cost PMS in India and at 0.25%. I would say it is very competitive with low cost mutual funds, but we have some disadvantages compared to mutual funds.

Vashistha: Taxation

Deepak: Of course, there is taxation, and we’ll talk about that later

Vashistha: But before we move on and this part about fees, there's this other thing that keeps coming up and we got a lot of these is ‘skin in the game’. Where is your skin in the game? Then if you're not charging this performance fee, how do you manage? How is your interest aligned with my interest?

Deepak: Yeah.  I mean, I love this. I always think of this as there are always two ways to look at a problem. First is the way you think is right and then the second one is, once you try that thing that you think is right, you realize what is right. So, it's a second order problem, right? So let us say the first order is you think of skin in the game. Oh, you have skin in the game. We'll make money when you profit. We'll also charge you a management fee, but that's different, but we will make money when you profit. So, I will try to maximize your profit.

And so actually doesn't work out like that. What happens is the PMS manager gets maximum enthusiasm to take as much risk as he can because he doesn't participate in the downside. What happens if he loses money? You take your money out and it's over.

Vashistha: He’s charging a management fee anyway.

Deepak: Yes, he's charging a management fee anyway, but if you make money, he's going to participate on the upside, so there's an incentive to take a lot of risk now. This is something we realized in 2008. A large mutual fund whose name starts with ‘F’ had a PMS product in 2007.

And it was very heavily sold, and people thought this name, which is an American-British name, fantastic, and all that stuff and they had a PMS which fell 80% in 2008 because of course risky stocks in a market that fell 50% will fall 80%. Now, when you fall 80%, 100 becomes 20. Now you must make that 5X just to get back to a point where you can charge a performance fee again. Remember performance fee is only for performance from the 100 onwards, right (this is the concept of a high watermark)? So, if I give you 100, only if you make 120 (above 100 basically), you can charge me a performance fee.

So, if 100 has 20 twenty, I need to get back to 100 to be able to charge your performance fee in the first place. So, what this particular entity did was to shut down the entire fund and said, here's 20. I'm sorry. We're shutting it down. The next day, they called you again and said we have a new PMS. If I take the 20 that you have and perhaps you can add a little more money onto it, I can start charging you the performance from the 20 onwards and now my risk is a lot less because the markets have fallen 80%.

Of course, it's going to go up at some point, but the point was you've incentivized the managers to do exactly this. Shut it down when the market falls. So that they can reach out to you; (maybe not you, maybe your friend and say we start charging you from day one now, and as a performance fee.

Vashistha: And the marketing is awesome, right? If you only make money when you make money and so on like our interests align. Look, why I'm incentivized to get you the maximum returns is because that's how I learn my fees.

Deepak: Honestly speaking, many mutual fund and PMS managers would rather have their skin in the game. In reality. That means they put their money into their own fund rather than try this complicated approach of saying no, no, no I’ll make money when you do. What happens when you do this performance fee business is that the distributor makes money because anytime a fee is charged, the distributor says I want my percentage of the fee which is 50%. So, it's a way to incentivize your distributor as well.

Vashistha: If the market goes up, I will get more. OK. Let's take our example. Momentum in our portfolio in PMS went up 100% plus.

Deepak: Yes, in two years, 121%. In one year, 100+

Vashistha: We still made 1%.

Deepak: We still made 1%.

Vashistha: If we had charged a performance fee, how much would we have made?

Deepak: Let's say we charge 15% just to give an example, we have made 15%. I mean, momentum is now 215-220 Cr, and if performance was about 60-70 Cr because the sums would have changed overtime, just the performance of 60-70 Cr, we would have charged 15-20% of that. That's nearly 10 Cr, which would have charged versus making just 1-1.5 Cr or a little bit less than that.

Vashistha: By the way, we didn't make 10 Cr for the whole year.

Deepak: Not exactly, and we're basically playing a long game here. We're saying, if we make you money, you'll stay with us. If you stay with us, we can be here longer. We can show you how these strategies work over the long-term and what we call momentum, what people think goes is, the market has gone up a little and we’ve gotten out. It is a long-term strategy. It's not a short-term strategy. It's a way to build your wealth for the longer term, even though there may be a lot of transactions. The shop does not make money by keeping a bottle of shampoo for its customers for the whole year. He makes money if the shampoo moves and then he gets another shampoo and then the other shampoos and then so on.

In a way, sometimes the money is made over time, because we don't make any money from transactions. We do not own a brokerage. We use an external third-party brokerage which gives you the cheapest rates that you could ever get in any to the point where a mutual fund would look at us and say how have you got these kinds of rates because you know, for them, it's shocking. But we have built it in such a way that our broker and our custodian (we use a custodian, we'll talk about that). Have the least amount of effort because all their work is done through technology.

Vashistha: We do a lot of the work. We don't rely on any third party to do any work.

Deepak: Well, sometimes we must do the work of the third parties for themselves, but we'll come to that later. It's a pet peeve, but we've said right from the beginning that listen, we will not leave any stone unturned to keep the costs as low as possible so that we don't have to charge you. I don’t want to make a loss on this, but I don’t want to do it in such a way that I profit here in a much higher way than other people.

And in the long run, this is what makes money. Vanguard has shown it to us. Blackrock has shown it to us. We've just got to follow them. You know, stand on the shoulders of those giants rather than stand on the shoulders of the giants of India who have been charging you 2% + 1% setup plus 1% annual fee plus something else. And you know, so I think that is where you know, long-term focus isn't coming to the point which you mentioned. I mean, what? What made us do this?

Was this thing that said, we've been proponents of direct plans, but nobody sold direct plans. Now we were. We could sell it and make money. Otherwise, if you sell a direct plan of a mutual fund and we were charging a smaller fee, I think at the time for debt funds, some of it was roughly the same rate, but the idea here was that you were charging for a service that included direct mutual funds, and included stocks and included a way to balance the two, get an SIP, automatically manage it, target longer-term goals, and do the whole thing without resorting to things like profit sharing over trading and you know all these concepts that we were we were against.

Vashistha: And our customers. The way our customer profile is, most of them are not coming to us like because you are the best stock pickers in the world or I want this strategy, maybe for momentum. But I think the reason for going to a PMS is outsourcing discipline. Because otherwise on your own you might keep jumping from one strategy to another and you know you might not get your asset allocation right and you know how much cash I should keep now (or not). You'll be making all those decisions. We basically outsource all this decision making to a portfolio manager.

Deepak: Yeah, in fact, I think that point is greater than any of the stock picking expertise that I've ever seen. If you look at the concept of portfolio and even now if you're trying to build yourself your own portfolio, you might think I have to pick up the right stocks.

Otherwise, it won’t happen. Right stocks at the right price. Otherwise, I'm not going to buy it, but that is wrong. It doesn't matter what the price is. Sometimes you can buy a great stock at a higher and higher price every day. You do an SIP, the mutual fund picks stocks. It's NAV is going up. You are buying more and more of it at the same price. Why do you think that will be OK, but you still have to buy all the stocks at a low price? I think the idea should be that the discipline of identifying great stocks is one thing, but the discipline of participating on a consistent basis is a much more difficult process.

A stock you own, goes up 30%. Your first thought is, should I book profit? Ok, I’ve booked a profit. I'm very happy, I paid some tax and now the stock keeps going up. Will you put your money back in? Answer, many times, no.

Vashistha: This is the question you've kept getting on one of our stocks.

Deepak: Garware. Yeah. When we first identified this stock, before the PMS itself, it was at 195. It was a small cap, 300-400 hundred Cr at the time, and you know, we said OK. Let's buy it and then it was 350 and we said OK, no, no, this is a great longer-term story. Let's put it in a long-term portfolio 350 became 500. People said it's 500. Why will you buy it? Now you buy it because it's a good company. It became 1,000 and it paused at 1000 a little bit.

People said, “How can I buy 1000? Isn't it at a new high? It's at 3,000 today. We've got this question on Slack. You can literally search for it and say is it too high to buy? And that talk is always going to figure, because no matter when people have asked this question, it has gone up another 10% from there. And now it's set at 3,000 plus, so it's an interesting story of saying listen, we don't know whether this stock is going to keep going on. I have no idea.

But all I know is that the discipline of buying was the one that made the money. If you didn't have the discipline, you would allocate too little to the stock. And if you have a 1% stock that goes up 5X, you made 6%. If you have a 3% stock, that goes up 3X, you've made 6%. Literally, it doesn't matter how many X it goes up. It matters how much you've invested in it and how you've consistently managed to invest more in it over time.

As you've gotten more and more of it, sometimes it's just a matter of conviction. Sometimes it is a matter of listening. There's nothing wrong with this. And when something is not wrong, I can put some more money in because my net worth, my incomes, and my savings are going up? If I had to retain a stock at the same percentage of my net worth, then I must invest more on it every month.

This concept is very difficult and when you outsource it, you take that thought process away. Well, even I outsource discipline. I must be honest; I don't invest in any stocks on my own. Of course, at some point I may not be able to because I'm a PMS manager. But I invest all of my savings into the PMS.

Vashistha: As professionals in this field (investment management) even you would not have the time to buy stocks in your account and keep track of them and so on. It would be more efficient to do it through the PMS.

Deepak: I have personally thought the same problems that I'm talking to you about, which is, is this too high to buy? I just bought it last month at Rs. 500. Now it is Rs. 700. I have the same thoughts for my own money. It's like a doctor treating himself.

Vashistha: Let's compare this. Before the PMS you would have bought something. Now, as a fund manager you just make the decision whether to buy this stock and how much to allocate to it, by not doing the transaction yourself and that the system does it and the organization does it. How much of a benefit is that versus, you know, buying it yourself?

Deepak: I can tell you this and because it's not just because of the portfolio, but I've been adding stuff and I have a certain amount. I have about 15% of debt in my portfolio in the PMS, it's up over well now about 40% this year, which is calendar 2021. Not just because of the amount that it's gone up by, but also because of money that I've added to it. And I mean, it's probably half and half, a little more than half. The problem that I had was every month if you had new money, I would have to now think of which to buy, which stocks to buy. I could buy more of the same stocks, or I could buy a new stock if I must do this at my personal portfolio level.

I'd be like, yeah, I must research all of this again and find out. OK, let's say I do find out. I'll under allocate to some stock, over allocate some others. I will make stupid decisions like; I think this stock is not going anywhere. Let me get out of it. Let me buy something else that's going somewhere without having a systematic thought process around it.

At the PMS I just trust the process because when I go to look at the stock list as a PMS manager and I think, are we in the right place or where we want to be, and do I need to change things when I'm looking at that?

I'm looking at the overall portfolio as if it's a fund rather than looking at it as each individual person, does he deserve to have Reliance in his portfolio, I don't know. The answer is, I have a standardized approach to looking at equity. Let the system do all the rest of the grunt work. How much must he allocate to equity versus debt? How much of that equity needs to go to this stock is determined by the system and the beautiful part of the whole thing is it just works. I mean in the end it just works. Makes your life that much easier.

Mutual funds do this very well. They've demonstrated to us that if you just continuously do an SIP inside a fund, it may not be the most optimal strategy. It's more important for you to save and you know, put, invest the money then it is to target the higher returns. If I can make 10% less returns, but it gives me the happiness of being able to invest Rs. 100 every month and I just stick with that discipline; it would be greater than me finding that little percentage higher return but not investing Rs. 100 for eight months and only investing for 2-3 months. I'll get a higher percentage return. But then maybe your pocket matters. How heavy your wallet is, matters more than whether your wallet has a shiny exterior, right?

Vashistha: It's interesting because you mentioned mutual funds, and maybe here's a good place to compare a PMS versus a mutual fund. So, in a mutual fund, the mandate for the fund managers, basically you have given me money. I must invest. I don't care and I don't even know that. What is your financial situation? Should you have 20-30% cash or what? I don't know that. So, basically you give me money. My job is to deploy that money in the strategy that I'm, that you've invested in. So, if I'm a flexi cap, then I'll go and buy these stocks and that's all I will do. But in the PMS, that's where it's different, right? You can make asset allocation decisions.

Deepak: I think two important things, or three or four. Mutual funds have one advantage. They are not taxed in your name. We'll come to that, but let's look at the conceptual understanding of a PMS first. You give money and they can choose to deploy it in different kinds of assets. And that asset allocation can be determined entirely by the portfolio manager, so it can be 80% at one month, 20% equity that month, 75% equity the next month because the markets follow. This is completely left to the discretion of the portfolio manager. Mutual fund managers do not have that discretion.

Vashistha: Are you bound by the rules that should be set so you can't go below 65% equity or 80% level if you know more than 20% in mid cap small caps.

Deepak: Yeah, and they determine who the large caps are, so you get the universe of 100. It's almost like saying these are the ingredients in a large cap fund. I mean, it's like MasterChef at the mutual fund level. I mean really, this is all the ingredients you have. You can't do anything more. I mean, you can't take anything more, and then you decide between that. So, you're working on this a little. It's like saying listen, I am going to run with a helmet and a full space suit and I'm the fastest runner over here. It's great because mutual funds do it consistently well. 

So, for instance, a mutual fund manager cannot be more than 10% in any one stock up. PMS managers can have 50% in the stock. It's perfectly legal because it's allowed now. Same thing. A mutual fund manager must do a certain set of things. He must vote on the holding because effectively, he is the owner of the stock. The mutual fund managers vote in meetings and all that stuff and keep a record of it.

The PMS manager does not do these things. The ownership is yours, so the PMS manager may choose to inform you about it. But a PMS manager can do a few things which are to go to cash. 65% equity is required by the Income tax Department for equity mutual funds. But there is no requirement on a personal level that you need to be 65% equity at any point in time. Why do you have to be 65% equity in the time that last year when the market fell so much momentum was at one point, 80% cash. You can't be 80% cash in a mutual fund, you know all hell will break loose. SEBI will probably shut you down, lock your office and go away.

But this is not the same as PMS. PMS can have as much cash as they want and go back into equity whenever they want. They have some common rules, so for instance when a PMS buys, it must have the cash in the bank account, which means that I can't sell a stock and buy on the same day.

I can sell a stock. I must wait for two days for the cash to come and only then can I buy it. So, you'll need some buffers to make things happen. Second, a mutual fund and the PMS cannot leverage themselves, which means. I can't buy a future or option of Reliance, simply because I think I want to participate in this future because the rule is that your gross exposure cannot be greater than the amount you've invested, which means I cannot lose more than I've invested at any point in time. So, margin trading is only allowed to the extent that your overall exposure is limited to the amount that the customer is invested. This is the same whether it's a mutual fund or PMS.

By the way, in Capitalmind, we don't do any futures and options, but I'm just saying that this is a limitation. In mutual funds, taxation is very efficient. So, what happens over here is the mutual fund can buy and sell stocks.

Vashistha: OK, that's the one big advantage they have. But now even long-term capital gains tax, so it kind of shrunk a little bit. But you know, maybe if it's not a very high, frequently traded portfolio. Then the difference is very little between a mutual fund and maybe doing it yourself or via portfolio manager. But if it's a very high churn portfolio like momentum, that's where the tax efficiencies really come into play.

Deepak: And you know, I can tell you this. I've been looking at mutual fund portfolios for years. They churn the portfolio like crazy. Maybe not as much as momentum does, but don't tell me that they don't do 35% churn. Some of them do 35%, some 40%. There is a tremendous amount of churn. Sometimes they get in and out of stock so easily. You don't realize it because you don't have to pay any tax on it. It's not in your account, it's in the mutual fund account. So, the mutual funds themselves aren’t taxed and when you exit the mutual fund is when you are taxed.

Vashistha: Tax is one thing. There is also the transaction cost and one of the biggest components is STT.

Deepak: 0.1% is what you will pay as STT no matter whether you do one transaction or 10 transactions, the more transactions you do, the higher STT you pay. By the way, do you know that your TER in a mutual fund, (total expense ratio), does not even include the STT?

So, it means that if a mutual fund went and bought, it did a 40% churn. if they had 100 rupees AUM, and they bought ₹40 worth or sold ₹40 worth. You effectively have paid on that Rs 40, 0.1% as a year as STT. If they bought another 40, there's another 0.1% that they have paid. That's 0.2% (on Rs 40). That 0.2% does not reflect in the total expense issues. So, a fund can tell you, listen, our expense ratio is 0.3%, but they’ve spent 0.5% you don't like.

Vashistha: I don't know other PMS. We show the expense ratio calculation breakdown of all the fees in our PMS, and you can see it as a percentage of your average. You can see the  real expense ratio for you. A mutual fund is never going to give you an invoice. Yes, that's in fact a big problem because all the expenses that they do, they do on your behalf effectively as part of a pool.

Deepak: But you never get that invoice, and you don't know how much STT was paid. You can glean through the financial statements of the mutual fund which they're supposed to give you, and I challenge you to try and find the STT separately, it is very difficult. In many cases, impossible because they don't reveal it, and they're not required to.

Vashistha: They just add it to the cost.

Deepak: They just added to the cost, so you don't know what your actual cost was at the time of purchase at any given point in time. Even this is legal. This is perfectly allowed, but what we said is let's distinguish those costs from our buying prices and selling prices. So, I'm going to show you about Rs. 123 and that you paid at this point 1% as tax over STT rather than saying no, you bought Rs. 123.2. I could do that, but I think it's not fair and the STT should be shown separately.

I also feel that in the longer term there will be a requirement for funds to reveal all of this. Now in the US, if a mutual fund does a sale, the taxes are borne by the investor (customer). So, if you're an investor in the fund at that time, that proportion of tax is yours, so you're supposed to file it as returns. That's the reason why, in the US,  ETFs are so popular. Because I don't buy and sell in the market at all. They just do a transaction with a market maker, which is a bulk loading of units. A transfer of units against a bulk portfolio of stocks, so it's not considered a buy and sell.

In the US, if you invest in a mutual fund versus an ETF, you are responsible for paying the taxes that are attributed to you when you buy or sell stocks.

Now this is very interesting because at this point India does not have this rule and if this rule was ever going to come and I don't think it will because that will destroy a lot of businesses, but this would make then the PMS equivalent to a mutual fund. But till then the mutual fund has a taxation advantage.

Vashistha: This is interesting where you mentioned about the US thing even here. Is the same right? They don't buy directly in the market. They have authorized participants or somebody who's buying the units. They get charged STT. The fund itself is not paying the STT versus an index fund that must pay their STT.

Deepak: Which is why the index funds in India have a tremendous tracking error and that tracking error is negative. So, you're always like 0.4-0.5% less than the index itself. The ETFs, on the other end, are 0.11% less and you're wondering why and you're saying Well, if it's three or four transactions that they must do for rebalancing, that itself adds a 0.2, 0.3% that will take away from the fund but regardless, when we and we have applied to be a mutual fund, just you know, for full disclosure.

Vashistha: Full disclosure.

Deepak: We plan to change this game because this is a tremendous amount of cost and we want to make it such that if you're an index fund, you don't care about the STT, I know because you're like OK dude, just give me the index return so I don't want to hear your excuses of STT and this and balancing error and all that my job is going to be to find a way to get you to the maximum in closest to index return as possible without, at any point, doing something that would give you more risk than the index, so I shouldn't do things like saying I'll buy a little more Reliance. 

So that you don't have to buy it tomorrow, that kind of stuff is not acceptable, but if I give you the same risk as the index and I got you a better return, my total expense ratio can be 0.4%. It doesn't matter. What matters to you is after my expenses, am I closer to the index?

Vashistha: To the index through expense ratio that is your tracking error basically.

Deepak: And you know, at the PMS we can't even do it because as a mutual fund, you can get a tax efficient vehicle. If I did the same thing in the PMS, you would a) Receive the dividends in your account. That dividend would be taxed in your name since dividends are taxed now. B) you would have the transaction rebalancing cost plus STT in your name. I couldn't do any of the optimizations that we want to do as a mutual fund in the PMS, but that's fine because the PMS is not meant to do that; the PMS is meant to build personal portfolios for people and try to get them as you know, as efficiently as possible.

Vashistha: Since we're talking about personal portfolios, let's talk about how the portfolios in our PMS have evolved and not just portfolios or strategies as well because we started with only the long-term growth type of portfolio which you were managing and then we added a passive portfolio, we added a momentum portfolio.

And then we have these different strategies, different ways of allocating to these equity portfolios, and you know managing asset allocation, how to have debt and then move money slowly into equity and so on.

Deepak: Yeah, in fact. So, look at two things. I think when we started off, we said we should have one strategy and that should not be something that transacts very often (change stocks very often). Largely mid-caps, interesting stocks. So, we build a portfolio of about 25 to 30 stocks. We said, OK, let's build this out and buy these for the long term.

Over time this is a very similar strategy to most mutual funds. Somebody is going through stocks. They're saying this is a great stock. I will buy it and I could give you stories over Garware Fibres which is now up to 3,000 plus. Or I could give you the story of something else which has fallen, and you know we exited that portfolio sometime, but the point about all these things was that you were not any different from the mutual fund that you were competing with, effectively by just saying that listen, Trust me, we can identify better.

Vashistha: And then it becomes only a game.

Deepak: Yeah, it is and you know in the end the game of returns is often what people love to see in the market because they gave me better returns, but we've seen this in HDFC mutual funds. Their fund managers were fantastic in 2007, 2008. If you look at five years, three years, six years, any amount of data on mutual fund data, HDFC was absolutely the top return in the equity portfolio.

Today 14 years later, 2021, if you look at any three-year, six-year returns, or nine-year kind of returns, HDFC mutual funds’ equity portfolios (equity mutual funds) are not even in the top 10. And they're not even beating the index. So, you said, HDFC mutual fund was an aberration. In 2013, there were IDFC mutual funds’ equity portfolios. Today then well, more well known for debt because their equity portfolios languish in comparison with the index also. So, what happens really is this game of returns is one for short periods of time, people make a lot of money.

I mean, when they highlight those returns, the longer-term nature of those returns, sometimes you will not find it as convenient. So, I don't think people chase returns or they want to chase returns. In the end what they really like is comfort.

I will deal with a smaller return if I believe that what you're doing is best for me, so I can tell you about a Capitalmind PMS’s phenomenal return, but you might still stay with the PMS you are using. You will say, listen, I'm comfortable getting 15-16% returns. That's all I need. I don't care about your giving me 100% or 90% because I don't even know if you're a one-trick pony. If you're a one-shot winner and after that you won't win against this guy. This is consistently performed for me over time, so to build that confidence you have a much deeper strategy than this.

Some people solve it by saying this is my philosophy. I buy these kinds of stocks and if you believe me, stick with me because I will only buy these kinds of stocks. Again, now it requires a certain amount of sophistication for somebody to even understand what that means. But most of our customers will come to us and say, ‘whatever you say’ because I'm not really going to go down that route and say is the stock? I want a stock whose ROE is 24% and plus.

And more, many of our customers are going to look and say, if you say it's 24%. Plus, I believe you because I'm not going to go through those financial statements that this is 23. Why did you buy it? And you know. So that's not sometimes the philosophy is at some point not just lost, but people are saying, listen, whatever makes it happen. I just want to trust you people, so you must build that trust. Also maintain the integrity that says we will honor it, but more so here's the part of the portfolio that changed. We said, OK, let's target good returns, but also build the framework that is acceptable.

So, the first year or so because of our mid-cap focus. Let's just say we shot ourselves by not doing the thing that we were good at. And the only thing that we're good at doing is being quantitative about markets. In 2019, suddenly, you know some light bulbs start flashing and we said, OK, we can't be doing this when we are doing so much better with the quantitative strategies that we are offering our research customers. But we were trying to do the same mutual fund.

Vashistha: Two things that happened. 2018 is when SEBI released the mutual fund recategorization, which meant that and since then most of the large caps in the last cap space, the alpha has just vanished.

Deepak: Yeah, in fact in 2018 we started to discover this was happening even before because a lot of funds were to call themselves small cap were not small cap. You could find a small cap fund with 20% allocation or 10% allocation to HDFCs of the world.

Vashistha: HDFC is a cash position. We want liquidity, no!

Deepak: SEBI came up and said listen, you're a midcap fund you should have 65% in mid-caps or large cap under 80% in large caps. I will tell you what a large cap is, and I will tell you what mid-caps are, and I will tell you what a small cap is. Now everybody must reassign their portfolios. According to this, what is now interesting is that because of this, the large cap funds and this is where about 80% of mutual fund assets reside. The larger cap funds were primarily investing in the top 100 stocks.

There is no information arbitrage available in those top stocks, and we started writing about saying listen, why can't we buy index funds in India now that these new rules have come, not just because of the new rules, but because the information arbitrage in the top 100 world has already been lost. Let's look at the large CAP funds in comparison with indexes and true and lo and behold, the three-year, four-year, five-year returns.

10-year returns were fantastic for mutual funds. There was information or arbitrage 10 years ago and that they've used that to their advantage. But from the 2014, 15, 16 timeframes that information or arbitrage was lost. This is not political, but it just happened during that time frame. What we found fascinating was that a simple strategy of and now this is where it gets very interesting. The Nifty 50 and Next 50, which are the top 100 stocks in India, were already starting to beat most of the mutual funds, but you add another layer because we were using Amazon, you were using Facebook. You were using Microsoft, using Apple- a lot of people are using Apple and paying $1,000 for a monitor stand, and you know you want a piece of that action because I won't buy their product. But man, I want a piece of that company.

You want that in your portfolio because that is what we were using. I'm using stuff on Android; we are recording stuff on a tool that was built by an American company which is listed on the US NASDAQ. We're going to put this podcast on a tool or a video that might be on YouTube, which is a Google company or a podcasting platform which like Spotify or any of the others which can be accessed using all these companies, are listed in the USA. And I'm thinking at some point we started thinking of this and saying why can't we have that in the PMS.

Now a PMS has to invest in Indian listed instruments. Today, we said we could use a proxy called the NASDAQ 100. There was one ETF at the time, and these have existed since 2011, and we said at this time it's a great time to start investing in this for our customers. Take the top 100 US, take the top 100 stocks of India and add this NASDAQ position. The combination of the two and when we back tested it, it was unbelievable that no mutual fund had been able to consistently beat this in the last five years.

And we said, OK, this is interesting. Maybe it's because of the NASDAQ, but I'm saying even before the NASDAQ we were seeing considerable underperformance. Just the Nifty 50 index 50. But yeah, the NASDAQ suddenly you got to a whole different level. This became the passive portfolio. You know a very peculiar thing that happened in November 2018 or before that. The ETF could be bought on the exchange, but you must pay roughly a 20% premium to its underlying NAV.

So, if you wanted to buy an ETF, you must typically put in a large amount of money. Motilal who is the manager of that ETF said pay us three crores to get the NAV.

Vashistha: Because they have a lot size and…

Deepak: The lot size was one lakh units, and it was ₹300 per unit at the time. So, we must pay 3 Cr, otherwise you know if you want a smaller unit please go through the exchange and buy. And if the Nav was ₹100 and the exchange was selling for 120.

So of course, before we start the PMS the first thought process was how can we make money out of this. So, we went, and we arranged for three Cr.

Vashistha: Deepak, I think it was 4.5 Cr.

Deepak: Yes, it was around 4.5 Cr., and we were able to sell that on the market for 20% higher.

Vashistha: If we had just held on to it, we would have made so much more money.

Deepak: Yeah, that's unfortunate. So, we made that little bit of money and then we got excited. Then Motilal realized that this is a problem and that more and more people may be interested in that. I'm there. I think at that time the total size of this portfolio was just about it was...

Vashistha: Less than 100 crores in AUM. It is now 3,000 or 4,000 Cr.

Deepak: Yeah, some crazy numbers like that. But what we did at that time was to introduce this in the Capitalmind PMS, the Wealth PMS itself saying this is a passive portfolio. And at the same time, we introduced the portfolio which we really, really identified with, which is momentum. The concept that a stock can go up and keep going up, and this is where you know I'm excuse me for you know advertising our portfolio so much.

Vashistha: No, no, this whole episode is an advertisement.

Deepak: Hahaha. Yeah. We are not going to mince any words there. Momentum, I think is inherently, something that all of us are passionate about and I think the reason we're passionate about it is so innately human that something that does well continues to do well for a while, and it's so non-intuitive because I can tell you that if Rahul Dravid, forget him, he is now an angry young man in Indiranagar. Let's say Virat Kohli is in form. You are expecting him to go in every match and hit 100. And when he doesn't hit 100, you're saying he's lost his form, or he may be losing his form. Let's give him a little bit of a chance. If he doesn't get 100 in two or three matches, consecutive, not even a 50, then you are saying he's lost his form. Now we do this.

Naturally, we don't have to explain it to anybody else why this is happening. We understand it intuitively. We also know that he's informed because every match or every second match he's hitting that 100 and you know that he's in form. You talk to people, and they say, Virat Kohli is in form. It's not just Virat Kohli. It's like Roger Federer is winning. He's winning because he's like one of the best and he's the greatest of all times. Because he's got this strength and he's always been winning. The point about some of the strength these players get when they play is that their confidence comes from having one in the past and that gives them a little bit of extra strength because it's not skill anymore. All these players are extremely skillful, sometimes it's just the confidence, the mental make-up, that little bit of extra energy that you get from the confidence in the code that makes you happen.

Now think of this in stocks. If a stock is going up, all its customers are seeing its stock price going up. They're seeing that your company must be good because your stock prices are going up and the managers of the company are feeling like they're telling their customers that our stock is going up.

Vashistha: People have recently discovered CDSL, BSE, and CAMS are a platform businesses.

Deepak: Yeah, I mean yes, you're right it suddenly it's not like they weren't, but somebody looking at the data and saying, listen, we've got 35 lakhs new accounts started in the last three months. Who's going to benefit? CDSL. So CDSL guys are thinking we must be doing something right. It may just be that this euphoria in the market that's giving them what they are. The point is that confidence gives them the ability to say let's try new things, resulting in more business, on a larger scale.

So, this is a downstream effect of it, but looked purely upon from a point of view of prices, there is our information asymmetry in the business, which means that there are some people who get to know about some news earlier. That may be because they're in the trade. For instance, if I have a hardware store and suddenly, I find my orders for Fevicol have gone up 5X. I talk to a few people in my trade, and they say, yes, Fevicol is flying off the shelf. I will go and buy a Pidilite. I'm not an insider, I'm just a guy in the trade, I'll say, this stock will start doing well because it’s, so he gets to know that information first I get to know the information second. So, by the time I got to know the information, it was because my friend’s friend was a hardware dealer and I bought this stock. I pushed the price up a little more then somebody in the TV channels picked it up. It pretty lights prices going up. Why? And the TV channel highlighting that is enough for hundred other people to say, hey! Pidilite price is going up. Maybe people are buying Fevicol. So, the thing about momentum is it's a positive feedback loop on the upside.

Now what happened to the downside? You might say, I think our prices will go up, but they'll come down. Somebody says there's a fraud here. Then everybody says it is a fraud. Here the answer is this. When it goes up, you can make 100%, but what if you said, I limit my losses to 25%. That means I will not let a stock hurt me more than 25%. If it falls, I don't care whether Fevicol is selling or not. I don't care if hundreds of people are still buying Fevicol, if the price of Pidilite share falls 25%, I am getting out because what will happen then is I will get out and then if there's a really a problem in Pidilite then price will keep falling and then you'll get some news that something is wrong. And that's when you'll say, oh well, you know, I don't know why, but the price was already going down, so I just sold.

The point of selling and cutting your losers first and keeping your winners, letting the stock multiply 1X 2X, 3X on the upside gives you a little bit of an edge, and all you need in the markets is a little bit of an edge if you do this consistently. What will happen is the first five or six months you may buy 20 stocks. You may sell five of those each month. There will be a different 5.

Each of those in the end, you may have only five or six stocks that you held for six months, then the rest of them are relatively new, but those stocks which you've held are starting to give you great returns the longer you hold the stock, the more likely it is to be profitable for you and to be immensely profitable for you. We've seen stocks that have given us 300-400% in four months and then quickly vanish from our portfolio then come back in.

This is the other part of our momentum that's still active because it gives you the discipline to say I don't care if I sold this stock 20% below this price. Because if I sold a stock at 180 and now it's 230, what’s your thought process? Yes, I'll let it wait. I just sold it for 180. How can I buy it at 230?

The answer is you can and you just hit the buy button at 230, you shut up and buy because when momentum is on it doesn't have or need to give you a reason. We knew this because we have run this in the Capitalmind portfolios. We've seen this as a portfolio. We've seen this done across a diversified number of 30 instruments. And we said, let's do this for customers. Maybe this is the redeeming thing, because this long-term multi-cap may take a long time and to be fair, long term multi-cap, now over a two-year period has actually done better than the index, but for a long time, it didn't. You know it took some time to come back to it.

Vashistha: But there is a learning curve, right? All portfolio managers who become fund managers for the first time, yeah, so you must learn how to construct the portfolios, how much to allocate toward how to reduce allocation, how to get something out, and so on. It is a learning curve for you as well as Anoop who's managing momentum well when you started like you started with 5-10 Crs in AUM, now it's 200-250 Cr. So, you can't really go and buy all the stocks that trade one particular day.

Deepak: Yeah, we can't. I mean no longer, can you? So, for instance, the same rules don't apply, and we've also discovered that you grow overtime.

Vashistha: Like in the PMS, you really don't want to get stuck with something like an ATGL or whatever, even though it is interesting.

Deepak: We were looking at the patterns and saying upper circuits. I don't want it. Anoop was saying this. I love this stock, but I can't take it in the PMS because it has upper circuits which proved very well because when it had lower circuits, we didn't have to get out of it at that time, but what is interesting from a learning perspective was that these portfolios, although they required action from us. The passive didn’t, of course, the passive was just buying.

Vashistha: We can buy efficiently because we can buy directly from the fund house, and you know, don't pay the premium on the market. And we end up paying a much lesser premium than anyone else in the market because we adjust our buys over time. Sometimes there are people who come and sell that ETF because they want liquidity. They end up selling it lower than the NAV. We can purchase those stocks at lower the NAV and average out to a point where your average buy price is much.

The good thing about some approaches like this is you outsource the discipline, and you also outsource the time because it takes a lot of time. Somebody sitting and looking at this price and maybe the NAV changes every two seconds. So, you must look at an SBI website or a Nippon website and say oh this is now 48.30 and my order was 48.20.

Vashistha: We can go and buy these index funds or fund of funds, but then their expenses are higher.

Deepak: Yeah, their expenses are 0.5% or higher. So, in five years you've paid 2.5% higher. So, I'm like listen, I'd rather pay 1% one-time than to pay 2.5% or 0.5% every year. We found that much more redeeming from a portfolio perspective. We added one more layer on this. Now we go to other PMSes. They have three strategies. They say 25 lakhs per strategy, which increased to 50 lakhs in 2020. So, if I had only 50 lakhs, why can't I get a taste of all? And we were like there's nothing restricting us from doing it. And anyway, a PMS is personalized. So, I could offer you some of one strategy, some of another one. You know you could take half your portfolio in debt and half your portfolio in equity.

Vashistha: Even goals. People said, look this is retirement, So I can take a little more volatile studies here because I'm invested for like 20 years. And versus a much more like goal that’s five years from now. You want much safer things. You'll only say a debt equity between debt and passive portfolio.

Deepak: Yes, and so now you get more and more towards interesting rules. So, for instance, one of the rules could be if you've never invested in equity before. Don't give these people the taste of a long-term multi-cap which can be volatile and require you to think for a longer term. Don't give them only a momentum strategy, which they might not understand.

Vashistha: And they might get scared quite easily with all the SMSs coming, hey! this got sold and this got bought.

Deepak: Yeah, so you want to avoid that. So, you say OK listen, let's do the passive strategy for you. You last this through for six months. Get a feeling of it. I mean top 100 India plus top 100 US. So, I feel a lot more confident that you will be there. This is not a portfolio of dead stocks and I'm always in the top 100. It's not like you know. If Yes Bank was in the top 100 that Yes Bank went out and some other stock replaced it. We don't have to do anything. The ETFs automatically did their task.

So that's a good starting strategy. It's almost personalized at a risk level as well. Saying even though you may also, some people come to us, they may be more than 70 and they come to us and say, Deepak, we don't have any long-term thinking. We just want to allocate some part of our money to equity. I have enough debt where I am, so I say OK, don't do goals-based because you don't need to plan your retired life.

Vashistha: You need a way to deploy some of this money without taking any risk with your capital.

Deepak: Yes. This is where it becomes interesting, because we can do a strategy of a combination where we can see. Listen, take your core capital, and keep it in a debt fund. Slowly trickle the interest portion of what you earn (actually the capital gain) portion of what you want into equity.

Over a period of five or ten years, you will become 30% equity just because of the nature of the game.

Vashistha: And it's highly, highly tax efficient versus doing the same thing in an FD because of the magic of first in first out.

Deepak: Also, more than 80% taxes can be saved. You will pay 80% less taxes if you did this with a debt fund and approach to move to equity. What's also interesting about this approach is you won't hurt when the market falls, because at any point only the equity portion is impacted. The debt portion is relatively safe in comparison. Of course, we chose safe funds. Also, funds with short term government securities or funds with PSU and banking exposure. There is some risk there but not quite as much.

So, what we decided was that, so we had a few customers who said, listen, we like this strategy. Let's take it. These customers didn't even realize that the market fell 30% in March of last year or just didn't realize but didn't see the impact on their own portfolio. They're like, oh, we fell 2%, but that's OK because when you have a 10% equity and the 10% equity falls 20% that eventually impact on your entire portfolio is 2%, so you did a combination strategy of debt and equity with this dynamic movement, we called it Preserve. So, our goal is to have a strategy that says listen, we can try and build your long-term equity exposure without affecting your core capital and say that we'll try and preserve the capital while we give you equity exposure with the returns.

Vashistha: This is especially important to people who need that capital to be safe. I have done this for my mom personally. Because when she retired, the corpus was not large enough that it can sustain entirely just based on debt. So, you need a little bit of equity exposure. So, I said give me half and I will manage that half portion for you. And that half, I just plugged it into debt funds and every time the capital gains become one lakh. I just take it out and put it into equity funds. She's already at 30% equity because the market timing worked out.

Deepak: It’s brilliant.

Vashistha: And she doesn't need more than like 40% equity.

Deepak: Yeah, and you know what will happen now is even if debt returns were to collapse, the equity portion of the curve is giving you supernormal returns like we were talking about today. Today is a very interesting day because today itself our momentum portfolio, in the PMS, earned literally half of an annual return of the debt fund. Most of the debt funds are yielding 4-5%. One of our portfolios is up by 2.7% today itself. My God, there's such a big difference. But you know what? If you don't participate in equity, you're not going to see this kind of return.

Vashistha: This is a safe way of participating.

Deepak: It is relatively interesting, because when the equity markets are down, they won't hurt you as much, but you'll get a little bit of participation on the upside, when the markets are going frothy and crazy like they are today. I would say a balanced approach like this is far more acceptable and if you look at it and we created this right we said let's do an NAV, so you can see your portfolio. And say, Deepak, don’t tell me debt or equity or anything like just tell me how I've done. And I can show you I can show you how you've done as a whole.

This is like investing in one mutual fund, but nobody invests in just one mutual fund. People invest in five mutual funds. How have you done across those five? You've done different types. You've stopped the SIP in one and started this IP. None of that. You have some units of the other you don't know how much you've done.

Vashistha: This is our typical sales call where a lot of people say, look, we have this portfolio of mutual funds and then you know, try and do some analysis. We just compare it to our market index, the passive portfolio and say look, overall, you’ve underperformed this, so why do you want to pay 1%, 2% whatever to portfolio mutual funds of 10-20 mutual funds instead of just doing the simple thing.

Deepak: Which is quite remarkable. Of course, they may not know how much they haven't seen so far is how have their portfolio of mutual funds has done as a group rather than each individual one, because at any point in time I can give you a portfolio of ten mutual funds will say hey, these five are good because they've done better and these lower five are not good because they've done worse.

But you can say that for any five, because if you take the same ten the next year, it will be the bottom five that maybe on that become the top five, and the top five become the bottom five. So, you always have five good ones and bad ones, almost always. Which also means that no matter how you look at it, you must look at your portfolio overall rather than as individual pieces. The only people who do allow you to do that, or perhaps some of the new age startups if you buy those mutual funds from them.

Not if you bought it already. You already have it in your portfolio and so on. So, part of the technology that was there in the back end was also to show you NAV as a whole and then also a sub part so.

Vashistha: We're also the only PMS in the country to show daily NAVs publicly for all our portfolios. And the performance disclosure is daily. It is an API. You can build your own charting system if you want codes.

Vashistha: No, please don't say this. Venki will refuse!

Deepak: I mean, it could be built even if you could read it of course, but the big thing about this is that the system that we've used allows us to do this in a very transparent way. Now we also, for instance, if you're a customer, you'll be able to see your portfolio daily. That means yesterday evening's portfolio is what you see now. Many PMSes will not allow you to do that and show you only something.

Vashistha: The statement, once a month or once a quarter, or...

Deepak: Or something like that and they'll show you something that's like 15 days old because they don't want you to see the list of stocks. And I'm like, why? You own the stock.

Vashistha: There are PMSs who you know when they create the demat account they put their companies’ phone number and email address there instead of the customer.

Deepak: This is where I think we can segregate into how PMSes operate. But before we get into that, we'll also talk about deployment status, so one of them was preserved, which was this thing. There's asset allocation, which is, you know, stocks and debt and portfolios like that. The last part of deployment strategy we have is something called scaling in, which is like say, give me the money, we'll scale in over a period of six months and you can even add an SIP on top of that.

So, we'll take over the whole thing. We'll move from debt to equity over six months. You can keep adding money in the middle. It will automatically get deployed. Some of that money will go into equity. Some other money will go into debt because of your goal-based plan, or you could have a rules-based plan that says I want to only have so much in momentum and so much in a passive and it'll get spread between the two based on whatever rule we've created for you.

We're one of the few people that say the deployment strategy is partly under your control, but we have a fully automated system that says if you don't, if you don't want to do it, we have an algorithm that will automatically allocate to every pool of goal. We call it that you have, and that goal could be pure momentum, pure index or 50% index 50 debt and it will automatically allocate to these goals based on certain rules that we've predefined.

So, we spent a lot of time thinking through the tech so that we could offer the most flexibility with the least amount of complexity to the customer. The idea is we could have done a lot more. I could have said you can put 10 paisa here and 15 there, I mean all that stuff can be done, but I think we said, OK, let's simplify it as much as possible and keep it clean and easy to do. But now we just go back to you know how do I make it happen?

Vashistha: How does it work? What documents do we need to sign? What are the players in? How do you keep track of cash? What are the fees? How do I transfer money? What about anti-money laundering? What about taxation and all those things?

Deepak: So, it's very interesting, so let's start with the basics. I'm going to talk about the PMS industry, and then I'm going to talk about what Capitalmind does, some of which is slightly different from the industry, but still so the first thing that you must do when you start creating an account is you must assume that the PMS itself is going to have to create a new demat account in your name. Now I'm talking about discretionary PMS, which is about 90% of the PMSes in the country.

But there are lots of non-discretionary. They might be able to handle your existing PMS now. Earlier it was possible for you to have run through a demat account without a custodian. But since 2020, SEBI changed the rules about whether we started off even though we were less, we could qualify to not use a custodian, we start off with the custodian.

A custodial approach is basically a concept where you say that all your transactions are run through somebody who is not the PMS manager himself. So, I decided that we should buy stock. We may trade in a brokerage to buy that stock, but the stock should be managed in the custody of some other entity than me. There is a good reason for it is that it's possible that a person who has custody could misuse that opportunity and try and lend out that stock or do something else with it. SEBI said this right up front that we want to reduce the risk of any of that happening.

So, they've said you need to appoint a custodian. All mutual funds use custodians, all FIIs use custodian. And of course, many trusts use custodians. We said we use a custodian from the start. Unfortunately, we chose IL&FS Financial services, and we'll come to why that was unfortunate, but they were a much bigger entity than we were.

Vashistha: They were the biggest custodians in the country.

Deepak: So, we said, OK, let's go with them and you know. Everyone, including Zerodha, was using them for something.

Vashistha: Zerodha was using their (ILFS) demat before they launched their own demat.

Deepak: So, you had to open a demat account. So, the demat account provider in this case, IL&FS, would give you a set of forms to fill. This involves a KYC and proof of address, proof of identity. On top of that, there would be a power of attorney allowing us the PMS manager to be able to buy and sell stocks on your behalf. This power of attorney needs to be signed, and at that time there was another rule of SEBI which said that every customer must fill a form saying, I understand that you know this is a risky thing and they had to give it in writing. First, they don't even sign checks properly. How do you expect them to write entire sentences with legible format?

But that was a rule you had to do it, so you get a booklet of forms that you must sign. That booklet of forms will come to you and then you must sign them and then it goes back from the operational process.

Now there are two kinds of pieces. One is a PMS. Yes, I will open a bank account for you and trading account for you and trade in that trading account in that bank account using that bank account’s balance for you. Now this is a kind of PMS where the account is a bank account that is opened in your name. All dividends come to that bank account. All money that you transfer, you transfer to that bank account, but you do not control the bank account. The bank account is controlled by the custodian who gets a power of attorney to control it, and then they can debit that account with whatever and so on.

This is a trading account. You have 500 customers. You have 500 trading accounts and 500 bank accounts. This is how a lot of the PMS in the country operate. The rest of them operate on a different principle. It's where they say. There will be one custodial bank account single, so all funds of customers are coming at one point.

But those funds are used to buy stocks which go into individual demat accounts. So, you will have a demat account for each customer, but one custodial bank account is not managed by you, it's managed by the custodian, but the custodial bank account is where all dividends come and of every single customer and all proceeds of all sales come, and so on. Now what's the difference between the two, the point of having different demat accounts in different trading accounts.

Vashistha: Is this also an account where customers transfer their money if they want to invest more money?

Deepak: No, it's not. It's different. So, what happens is the PMS provider is the only one allowed to transfer money into that account. This custodial single bank account that I talked about. But what you do is you transfer money to the PMS provider like Capitalmind and Capitalmind then just transfer to this bank account, it's called the custodial bank account. There is a reason for this. If they transfer it directly, that account is under the control of only the custodian. So, for instance, if there's a custodial bank account, I cannot debit that account. I can only transfer money to that account. I can’t transfer money out from it. Only the custodian can. When people transfer money to it, the custodian says listen, this money is not from the person we have a relationship with, which is directly the portfolio manager. Then who is this person who's transferred money? Does it become very confusing for them? I say you guys maintain that account.

Vashistha: For the anti-money laundering thing that you have to take care of.

Deepak: Yes, at this point we must take care of the fact that this money has come from the right account.

Vashistha: We must be sure that it can only come from somebody that we can accept money from. For example, you are a customer, but your money is coming from your wife's account or cousin’s account.

Deepak: Yeah, I mean yeah, because that comes under the scope of money laundering. We'll both get impacted, so everybody must have a process. Many PMS don't follow this as a process very strictly, but this is how it must be done now. The next part of this operation is now what do you do? What's the difference between having individual bank accounts and individual trading accounts versus one bank?

Vashistha: OK one, let's recap. So, there is one account where customers can deposit their money. This is not the custodial bank. This is where they just deposit the money they deposit. We transfer from here into the custodial bank accounts from there onwards only the custodian can debit that bank account.

Deepak: Yes, from then onwards we don't have rights to do, but we can see the balance, but we can't debate it. We can tell our broker to listen, we have so much money in that account. Can you allow us to trade that and then we say, well, let’s trade? So now what I can do, for instance, is buy 100 shares of some stock and say tell the custodian. Listen, when you get the 100 shares, can you pay for all the 100 shares through that single bank account please?

Let's separate individual persons' bank balances separately. We have software to do it. Other PMS will use software like Wealth Spectrum and the back-end technology behind it to segregate the cash balances of each individual customer on a virtual basis. The bank account may say you have 1 Cr, but 10 lakhs belong to customer X and 5 lakhs to customer Y and so on. This segregation is done through fund accounting software. We've written our own fund accounting software and there is other commercial fund accounting software also available which you can use.

When you do this, you say OK, I have paid for 100 stocks. Who have you paid for it from? You must have the segregation of the accounts from which you paid for those hundred shares. So, eight shares worth of money is debited from this person's account and so.

Vashistha: And hence the eight stocks to be credited to that demat account.

Deepak: So, for instance, if I buy for you and me and I buy 100 stocks, I have 60 for you and 40 for me effectively 60 stocks worth of money is debited from your balance, which is the fund accounting balance that is running in the software and the custodian just pays for the full 100 and the fund accounting takes care of this and what they do is when they receive their shares, which is 2 days later, they transfer 60 shares to yours and 40 shares for mine.

This is interesting because this is very different from the way some other PMSes operate. Remember I told you there were two. The funds that created a new trading account, and so in those trading accounts I would have to log into each trading account. First buy in your account 60 shares, log out of your account, log into another account, put 40 shares there, and so on.

Now many of these PMSes use brokers who will then trade using trading terminals where they will just say we can switch the account. You know using a little click, a button changing the client code and doing the trades differently, but you still have a problem if a stock is going up continuously during the day. I bought 60 shares for you at ₹100. And then by the time I got to my account, I started buying 40 shares in my account.

Vashistha: So, every client gets a different buy price.

Deepak: Which is, which is lousy right? Because if the stocks go up 20%, one guy has made 20%. One guy has made 1% in the day which is rotten and what we decided right from the beginning was what we're going to do is have a single average buy price, even though we may buy through the day. Because we also won't buy all the stocks at one shot. We will buy throughout the day, and everybody gets the average price. Nobody gets a preferential price. This is now enshrined in SEBI rules saying that you must do this, but we decided right from the beginning this was the right, fair thing to do, of course. I think that rule of course existed at the time when we started, but we, you know, imbibed into the software itself.

And we decided not to create individual bank account, individual trading accounts for that reason. So, we could buy in a combined way, sell in a combined way. Everybody got the same price we got and although it was, it required us to keep a close match on balances. We set up a process to do so. Now what happens in the process like this is that we must make sure that the account balance is matched.

So, for instance, if I have 5 customers, one customer is supposed to have five lakhs with us in cash. That's not stocks, but cash. Another customer is supposed to have 10 lakhs. Then together, the two of them in the bank account should at least show 15 lakhs. Sometimes it can show 14. So, you’ve got to figure out why that reconciliation

Vashistha: We have to do a daily reconciliation.

Deepak: We've done a daily recon from 2017. In 2020, SEBI said every PMS has to do a daily recon. So, like, oh, fantastic. We've already done this. And you know, so it was easy for us to do it because we did it because we thought it was the right way. But now it's enshrined in a rule in SEBI and everybody else must do it, which is a good thing.

But it affected us a lot less than you know, because we could do it because we had the code. We had written the code to do it right from the start. Now with APIs, we can almost automate the whole thing so that we are aware of the differences between the two now. Another part of this operation is what happens when you want to exit. You know, so that's something that people say. Well, I want to close my PMS or can I have partially withdrawn from the PM.

Vashistha: By the way, if you partially withdraw your net balance should still be above 50 lakhs.

Deepak: Right now, if you're starting off as a customer who had the 25 lakhs limit, then your balance should be about 25 lakhs. So, either way, the idea is that you can withdraw up till the point at which the minimum was when you started the account with us, through SEBI. SEBI also has a new rule that says if you started off at 25 and we increase the limit to 50 and your 25 has now become 30. Can that person add another five lacks? The answer is no. He says you want to continue that account with those 30 lacs. Please go ahead, but you want to add. Please add at least 20 lacs to make it 50 and then participate because this addition of only five lacks is not possible. So, we said OK, that's fine. So, a lot of our customers then added the remaining.

Or they just said let's pause so they can't do SIPs until they reach the point at which it becomes 50 on its own. In fact, today right today, one of our customer’s accounts has literally reached 50 just on its own. So now that person qualifies to be able to add SIPs or lump sum cash, and this is an exciting time for us, because we can tell people that, listen, now you can get closer to your longer-term goals because you can do the monthly additions that you missed out over the last 1-2 years.

Now what's also interesting is because we don't have distributors. We can directly communicate with our customers or all these concepts without them getting lost in the ether, right? So, it was useful for us to build that relationship so that we could directly communicate. Now the second part of this is the distributed part of this frame. The distributors typically get all these forms filled. They come in. They do this, the fees start getting charged from the day the account opens.

Vashistha: Are entry loads still allowed?

Deepak: Entry loads are allowed. Exit loads are allowed. Lock-ins are not allowed in a PMS.

Vashistha: It costs us money. We do all the form filling. It must be printed on stamp paper. It can't be done online. You must get it done and then couriered; courier charges so on whether you become a customer or not. Eventually it still causes 500-1,000 bucks.

Deepak: We are perfectly fine with that because that's the cost of acquisition of a customer. And if I told people that was the cost of my acquisition of a customer, this would still be the lowest cost of acquisition of a customer in the country.

Vashistha: Because imagine somebody charging 2% but paying 1% to our distributor.

Deepak: Correct because that's a noose around your neck for the rest of your life. Because you may continue to service the customer forever. But distributors sometimes do add value, but the point over here is we realized that you know we had to print all these forms and write it at some point. I think the point was to listen, why do we wish to fill these forms? I think now because you fill them up with things. Sometimes they'll scratch. And then there's a scratch. The custodian will come back to you and say, guys, view, there's a scratch. The customer must cross sign across the scratch so the custodians would tell us please take cross signs everywhere, wherever you are filling in numbers. Please take a cross sign in, even if there's no scratch.

So, like what is this nonsense? We figured out the problem really was that somebody was writing the stuff by hand. So, we built a tool that said let’s take the data electronically. Let's fill the PDF in place, generate the form so that all only that the only thing people need to do is sign at the bottom of the page.

Vashistha: This is also now a SEBI requirement. You must allow customers to self-onboard.

Deepak: Yes, so now SEBI has said, don’t only have distributors. Let people come to you directly and remove the distributorship fee and give them a lower cost. Plus, let themselves on board. So now the PMSes are saying listen, I'm not going to fill forms with my customers.

We said we also don't want to. So, we made it such that all this data, if entered electronically, could be automatically filled in. And despite everything we would still have problems because customers will forget to sign something. So, we said you don't print anything. We will print it here. We will put little yellow ticks, you know little stickers on where exactly you need to sign so that when you get the forms, you just must look for the yellow stickers and sign there and send them back to us.

The unfortunate problem of form filling, but we have done that because now SEBI very recently has tried to allow digital onboarding (till now it was not allowed). So, we're going to be doing digital onboarding as well, because the only form that legally is not allowed to be digital is a power of attorney, so we'll have to get that only one form signed,

Vashistha: Instead of giving us like 20-30 signatures. It's just one.

Deepak: Yes, it will be one signature and you know it'll make a lot of people very happy. So, in general, if you go to any PMS, all this process will still be there now. Luckily, it's not there in mutual funds and hopefully it will not be required in PMS so, but that's the process. Now exiting/entry and the time frames. So, typically your time frames are five to seven days to get accounts started because that time it takes to fill forms and so on. Even exits take that much.

I'll tell you why, because if you're selling stocks, the earliest you'll get money is 3 days later. Then you must tell the custodian. Please transfer the money back to us so that we can transfer it to the customer. The custodian will take another day to do that, and then we take another day sometimes, so in the meanwhile we do things like verifying bank accounts and make sure everything is in place and so on.

Sometimes some stocks don't sell easily because there may not be enough liquidity so it can take a few more days to sell. That's another thing that we…

Vashistha: Particularly if it's a large account and you own quite a bit.

Deepak: Plus, what happens is maybe I have been buying for you. If you tell me you want to exit today, and I have some stocks that I have bought for you today itself already, I must wait for those stocks to come in before I can sell them.

Vashistha: It takes even longer for those stocks to be sold.

Deepak: Sometimes, those processes can take five to seven days. We try to keep our customers informed through the process, but that's the kind of time frame you should expect if you go to a PMS that it's not available instantly.

Vashistha: Who are all the players involved in the list of documents? See all these things. So, who is the custodian? ICICI Bank. Not ICICI Securities.

Deepak: Yes, so this is interesting because ICICI Bank is the custodian, not ICICI Securities.

Vashistha: And we will create a new demat account even if you have a demat account with ICICI Securities. This is the most common question we get. I already have an account with ICICI securities. Can you just use that demat account?

Deepak: Yeah, but basically what they're telling you is we are giving you an account with a lock and key around it. You can't touch it. We can't touch it. Only the custodian can touch it. So, in that case they're saying we are if you give me your existing demat account then you will do something to it. You will go buy some stock and we won't be able to reconcile our systems. So, you're not allowed to touch it, so they create a separate demat account. Second thing that happens here is, let me tell you this. The custodian can go bust. Our custodian did. ILFS Securities went bankrupt.

Vashistha: That was an interesting two months.

Deepak: That was an interesting two months because we now suddenly realized, OK, they've gone bust but still, is everything safe? The answer was each and every one. We didn't lose a single paisa during this entire process. What we did was appoint a new custodian, and transfer securities over to it. Took us some time because we had to open all new demat accounts at ICICI.

Vashistha: Open all new demand accounts in ICICI, close all the accounts over time at IL&FS, and you have to do a demat-to-demat transfer.

Deepak: Luckily IL&FS didn't go bankrupt overnight. It took some time before it went bankrupt. So, we were allowed to slowly transition, and it took us a month to transition it. During that month we were afraid to trade because how do you trade? Our broker said, listen who is your custodian? We couldn't say IL&FS because it was not. You couldn't say ICICI because we didn't have all the accounts yet. So, for about 30 days we didn't trade and transact. Plus, anyway, the portfolios were relatively secure. But what was interesting through this process was we learned something very interesting.

The Indian financial system is probably one of the safest in the world. The largest custodian in India went bust. But nobody saw an impact. Not from the custody operations. People saw an impact from F&O trading and a bunch of other things which we don't do but none of the custody operations across the world, across the market got impacted. We didn't either. We moved to ICICI Bank and if ICICI Bank failed, your securities would still be safe.

Vashistha: ICICI Bank is officially too big to fail!

Deepak: Fail yeah, I mean, so technically if it failed then you know your problem would be other things but not your securities. Beyond that, your securities are held at NSDL or CDSL, not at ICICI Bank. So, they're just a depository participant, so they use a depository participant license and their custodian license to work. So, you have a depository participant, you have a custodian, and you have a broker.

Vashistha: So, the depository, is like a giant ledger of who owns what and these guys are like the DB participants, are the accountants who make the entries.

Deepak: So, there in a way, if you think of it, it's like I have 100 ledgers. As a depository, I have 100 different ledgers. Each ledger says in the account of ICICI Bank we have a person X, Vashistha Iyer owning 100 shares of Reliance. In the account of Sharekhan same Vashistha Iyer owns 40 shares of Reliance.

Think of each ledger as a depository participant who says he has accounts and each of those accounts are different. So the demat account is with the depository participant. The same user can have different demat accounts with different providers. So, with a single PAN I can have an account with, ICICI, ICICI Securities, Zerodha, Sharekhan and they're all separate different demat accounts.

From tax purposes, they're different. The FIFO applies on a per demat account basis, so you can sell from one demat account and only the buys from that demat account get matched to the sells from that demat account for the purpose of taxation, even though you may have an older holding somewhere else.

So, the first in first out principle applies on a per demat account principle and therefore should be individually taxed separately.

What's also interesting about PMS is that since the accounts are separate, the depository participant is separate. The depository is separate, and so on. You can go to the depository itself (NSDL or CDSL) and get an account statement. You will see all the holdings in that account statement, which is also why it's stupid idea for us to hide from you what you own, because you can go to NSDL and ask for it.

Vashistha: The only nuance is that it will take two days to reflect on our portal. If you log in, you will see them immediately on the next day.

Deepak: Yes, because when I buy something on your behalf, I'll reflect that on the portal the next day, whereas I will have to wait until the shares are settled, which is 2 days later (t + 2) to show, which is a slight discrepancy, but the point is, the system is saved this way. But now how do you trade? I can't just go buy stocks. We are not a broker, so we use the services of a broker like a Zerodha.

Vashistha: Yes, in our case it is Zerodha.

Deepak: We tell Zerodha, we have a trading account. It is for the purposes of the PMS. We will go there and punch in orders. We will never give any money to Zerodha. Zerodha says this trade is going to be settled by the custodian. So ICICI bank says OK, how much have you bought exactly? 500 shares? That's fine, we'll pay for 500 shares, but we will pay the exchange directly.

So, we are one level safer, whatever broker we're using. If that broker goes bust, you don't have any exposure. Because you're not keeping any money with the broker, the custodian themselves are paying the exchange and receiving shares from the exchange or giving shares to the exchange and receiving money in from sales.

How does Zerodha get paid? They make a bill to the custodian saying, listen, this is our brokerage charges.

Vashistha: These guys got these many shares. I need money for this.

The custodian tells us, listen, they’ve asked for this much. I'm going to pay them. Are you okay with it? You say yes and then it's done, and all this is electronic. Of course, when I say electronics sometimes, however, it is by email. We will come to that because this whole industry needs a big lesson in how to use APIs and electronic transactions rather than email transfer of CSV files. But let's leave that on a different note.

Having said this, all this process is a concept of saying how complicated this system is. Because you're buying through a broker, it’s getting settled by a custodian with a common bank account through an exchange. The exchange has three layers. Now we don't just deal with stocks, we deal with mutual funds as well.

So, on the exchange you have clearing corporation and the exchange, all custodians are very good at this, but the mutual fund system has a different game altogether, so we use something called MFU. The broker must punch the order into MFU. We used to use BSE MF earlier, but that ended up having some issues, so we go to MFU now.

Vashistha: So, you go through the custodian…

Deepak: The custodian pushes the order in MFU, the MFU receives the money or securities and then confirms the order through an RTA, a registrar and transfer agent like CAMS or K Fintech. CAMS doesn’t sell the mutual funds we are buying. We are buying the mutual fund like an IDFC Mutual Fund through an RTA, which is called CAMS, the order of which is being punched on MF Utilities, which is a different company (the order is punched by our custodian).

Vashistha: Who got the instructions from us?

Deepak: You got the instruction from us. Five different entities in one transaction, and the transaction can fail at anyone. So, we have these different points of failure, so over time...

Vashistha: Which is also why our systems update the next morning because you have to wait for all these things to settle.

Deepak: Yes, and they all. I mean anything can go wrong at any time. Sometimes they will say Oh well, we didn't receive the money in time. So, you're not going to get two days and you will get tomorrow then maybe we say no, we're not OK with that. So, they say OK, then we'll send the money back to you. So, they take one day to send the money back. So, sometimes part of this is manual.

Because nobody knows why this transaction didn't go through. We call the custodian and say what happened? Where are the units? They will say, Wait, we will tell you, they call up MFU, and they will say wait, we will tell you, the RTA says, wait, we will tell you. And by the time you know all of this so we wait, wait, wait will tell you what causes like 90% of my gray hair, and a lot of gray hair in the company as well because everybody must go through this, Oh, my God. Where, where? Where is the money? Have we lost? How long is it going to take us to find the money back?

Vashistha: Yeah, it's not the money. I mean it will come. The problem is we can't update our systems because if we bought for 100 people, we don’t know the NAV we are going to get.

Deepak: Or whether we are going to get it and or whether we are not. How do I know whether I have cash to buy tomorrow? If the transaction did go through or didn't go through today. But now I think everybody got it licked and said OK well, things happen, this is how it's going to happen and all PMS.

Vashistha: Learning curve, everybody goes through.

Deepak: Eventually a lot of PMS do things, like for instance you can ask us, Deepak, you guys have sometimes had cash sitting in the account and if it's 2% of 450 Cr sitting in the account, you're earning no money out of it. Why can't you put it in an overnight fund and earn some money for the customers?

If I must deal with a custodian-RTA-mutual fund-MFU combination, where something fails and in the next day morning, I don't have cash to buy shares for whatever reason, that is a bigger nightmare for us than to earn that microscopic bit of interest that we will get for that overnight for this thing. So, we're like, OK, listen. This is the cost of doing business less complications, more reality when we get this system down to a tee, we'll do that. Also, we'll optimize and get you a little more return at that point, because yes, I charge you 1% fee. If I put that two or three percent of cash that we maintain, we might be able to offset maybe half.

Vashistha: But it's the same with mutual funds. We should also have 2 to 5% cash all the time because they must worry about redemptions and cash flow management and so on.

Deepak: But here's the good thing about mutual funds, since they own the cash and don't have to deal with these seven different layers. For instance, they could go and buy overnight TREPS over, or something like.

Vashistha: Correct.

Deepak: Where the money coming back in the morning is guaranteed, and they are already dealing with, say, an RBI.

Vashistha: But that return is not meaningful in.

Deepak: In anyways, yeah, so, and today it's not. Maybe one day when it is that the difference will be formed because of that thing, but the main important thing is the PMS can't earn money off that flow. If I earn even a single rupee by putting money into an overnight fund, all the cash balance that I have I know it's going to earn some interest. That cash by that interest has to be earned by putting their money overnight anywhere and has to be done in a format that transfers all that interest to every single customer that we have in proportion to that cash balance.

Vashistha: In proportion of their cash balances.

Deepak: I mean if we do this, you'll see like ₹20-30 rupees. You know that kind of number comes to your account every day and you load up a tax on that income but essentially, that is that. That will be an extra addition to your Ledger every day. Not many people do this, for instance. The broker could do the same thing and give you interest on it. A broker could allow you to buy a mutual fund every day and buy it back. They don't, and that's because of this complication. Something goes wrong. How are we going to track all this stuff?

Vashistha: But the cash is supposed to be cash. You need the cash because there's some transaction going to happen. And then cash can be there in an account for multiple reasons, right? You could have rebalanced and sold something. So, you are waiting for cash to come in.

Deepak: It's a receivable yes.

It could be a different net receivable, so it shows up as cash because it's going to come at some point and then you have some cash reserve because you want to account for fees and transaction costs and so on.

Yes, yes, because we receive, we don't ask customers. The PMS as well say, listen. I'll take the fees out of the money you give me, but if I invest 100% of it, how do I get a fee, you know, and the fees are important because that's what keeps the PMS running in the first place. So, you say OK, if we're charging you 1% a year, then 0.25% I can keep as a fee because I charge you on a quarterly basis. I don't invest 0.25%, I invest the rest. Then off the rest, some of those stocks will pay dividends. When they pay dividends, another 0.25% will come in, so I pay the first 0.25% and another 0.25%, that'll work for the next quarter and so on.

So, the typical fees are paid through this process. Taxes. And you know because divisions are taxed. Now all mutual funds are allowed to reveal at least what tax they must pay, and we even go a level further, we talk about how every individual has different taxation requirements, but there's taxation requirements that can be viewed in two formats.

First, When do I have to pay my advance tax so we show your taxes based on 15th of June, 15th of September, 15th December, because these are tax payment dates and what other gains you've incurred in those dates rather than all at once so that we can find out the appropriate kind of advance tax you have to pay on a real time basis? So, every day when you go, you can see what taxes you may have to pay based on income and dividends that you've received. The income is primarily from stock selling and capital gains, for us at least. And dividends and interest are for the user, so the user has to pay the tax on that. We don't pay the tax.

There is a good reason why we don’t because you may have multiple PMS. We may have made a profit; the other PMS may have made a loss. You can offset the two and not pay any tax, so we don't pay any tax on anyone's behalf. We expect the customer to pay it. Typically, if you're a salaried person, such a number may not be significant, and therefore you may not have to pay any extra taxes because your salary itself, the TDS that is being cut, qualifies for your tax payments.

However, some people who have business income or who have no other form of income, they are retired or so on, they may have to pay some of the taxes. Remember also that advance taxes are not paid by people who are seniors’ citizens, they can decide not to pay. If they have business income, they must pay, but if they have non-business income, they don't have to pay any advance taxes so they can wait till the next year for tax filing in order to pay.

Importantly, taxation is different for different types of trades, so short-term trade in equity is taxed differently from a short-term trade in debt, from a long-term trade in debt, a long-term trade in equity. So, we have a taxation module that helps you calculate, that segregates all of this and shows it to you on a regular basis.

Do any good PMS as well have this? I mean this is table stakes, everybody will want it, but we just integrated it into our portal so that you can get this kind of data on a regular basis whenever you want it, and if there's any tax impact of what we have. So, we also segregate for instance the NASDAQ 100. It's not, it's a stock that's traded on the exchange, but it’s taxed like a debt fund. So, we've segregated that part separately. Two years ago, the dividends that you received were not taxed. Now, they are taxed, so there's a difference between those.

So, we've built a lot of that technology to ensure that that taxation is right. Lastly, now, and unfortunately, this is a very complex mechanism. If you receive dividends of more than ₹5,000 in any financial year from one company as dividend, then a TDS of 10% is deducted. This 10% was 7.5% last year. It's 10% this year. So, we keep a track of that as well. Saying, OK, you should have had so much in dividend income off with so much has already been deducted. So, we kind of keep a track of that as well. And this you know, the tech team probably hates the whole world for this at this point, but this has happened and we've kind of done this in a way that goes on.

The last part about this is this. Every PMS is required to provide an audited statement of accounts to its customers now typically, and PMS will charge you 1,000-2,000 for such an audit statement. We don't, why don't we because what we've done is, we've said, OK, what does the auditor really need in order to audit your accounts? This is a certain piece of information: transaction statements, extra X&Y and so on.

If we can make their life easy by getting exactly what they need in the format, a balance sheet for each customer, a profit and loss statement for each customer, a cash flow statement for each customer, balances of each account mentioned entirely through technology. So, we generate these statements out of our databases.

And give it to the auditor, and the auditor says, listen, you've solved my work so much that I don't need to charge you that much larger fee that I would otherwise have charged you. I can charge you a lot less, so we absorb some of that cost and not charge people even though we can, because there's incidental costs. We say, well, we've made it so that it's a lot cheaper for you and we absorb that cost. So even if you were to charge you, that cost would be in the order of hundreds, not thousands. And that is so much that is so much in our ethos that we want to keep that we don't need to. We couldn't, we could have just said, you know, and every PMS does this in the sense they might just say the cost of the audit is yours. We've tried to do it in such a way that the cost of the audit is also taken. Well, every little Rs. 1,000 adds up.

Vashistha: Yeah, I mean, imagine somebody who's invested a crore in just our passive portfolio at 25 basis points.

Deepak: That's 25,000 a year Rs. 2,000 a month. If I charge you another Rs. 2000, I'm charging you a 13th month effectively, which is not fair, I mean. But also, I think you know this. It's the concept that says listen, we've made the system more efficient. Otherwise, one auditor would have to put three people behind this for 500 customers. And spread this audit concept over three months. We literally, once we generate all the statements and the balance is confirmed from our custodians and everybody else…

Vashistha: So now it takes 1 or two months.

Deepak: Yeah, it still takes us a little bit of time because we must confirm balances. What happens is, first our audit must happen and then customer audits happen.

Vashistha: We sent out our latest ones in June.

Deepak: We sent it in June this year. Hopefully, next year we'll try to send them in April as well so that we can have an internal company or by April and send the whole audit statements to all our customers.

These are audit statements. They're not tax statements. There's a difference. There are two kinds of entities. In India there are two kinds of taxation. Two kinds of profits in India.

One is the profits according to the Companies Act. And therefore, according to accounting standards. This is different from how the income tax expects your taxes to be filed. Which is your transactions and the capital gains and the short term long term, there is that dividend and all that stuff. That is a different format from how your audited statement looks, which is a profit and loss of balance sheet and so on.

To explain the difference, I'll probably have to go and do a course in accounting which I'm doing right now and find out as part of your MBA, again, a new rule from SEBI. The interesting thing about the difference between these two is that the taxation department may decide that certain things are not expenses. For instance, they'll tell you PMS fees are not expensive, but the accounting law says you can account for the expenses as expenses in your books.

So, the tax department will deny you a certain expense where the accounting laws allow you certain expenses, so you have two different books. One is to show the tax department, one you can  keep as your personal set of books which is allowable so because of this, you know this is very peculiar to India, yes, but this is how it is, and that's how the system works internally.

Vashistha: OK, so we've learned how PMSes work. The operations bit of it. Since this is done in the client’s name, right, it's your individual account, why not just do a Smallcase? So, what is the advantage of doing a PMS?

Deepak: That is a brilliant point...

Vashistha: We also publish our momentum portfolio as a Smallcase, yes.

Deepak: Yes, though our momentum portfolio is slightly different from what's in the PMS. The momentum portfolio itself is different because of reasons I'll explain now. If you do something as a Smallcase, what Smallcase will do is to place a market order for all those securities at 9:15 AM or as soon as or as soon as you press the OK button. This is not the most efficient way to buy anything, as we've seen sometimes the stock can jump up just because we are buying. If there are thousand Smallcase users, they can all buy at the same time at 9:15 AM and cause the stock to jump up 8-9 % sometimes, simply because there are not enough sellers in the market at that period.

So how do you optimize execution? Either you stagger it at 9:15, 9:30, 9:45 and so on, which Smallcase can do? But also, if you're buying a relatively small cap stock, you may end up raising it because you know normally also, there's not so many 10 Cr worth of orders are coming in one day, which is simply going to kill the stock volume because there's not enough sellers, so the stock will go up 10 percent, 15%.

Maybe you must buy it over three or four days because of the amount of money you're putting in now. If you're putting in one or two lacks, that's one thing, but we're putting in 50-60 lakhs into a strategy like Monday, because you really like it. You have the money to do it.

You're going to have to spread your execution and planner execution overtime. You can't do this manually. Now you are into 20 stocks that you want to plan. And all that stuff is a thought process that you don't want yourself to do, so we are careful in the PMS to include only stocks which have enough liquidity, and then we execute manually over a period rather than all at once. So maybe put a little bit over an order today now. And then a little bit of order tomorrow, and a little bit after the day after tomorrow. And so on.

The second part of this process is, how does this Smallcase you know, exit and enter. So, in a small case, you can sell a stock and buy back stock, buy another stock on the same day. This is an 80% rule.

Vashistha: That's a headache. If you are , say your 5 lakhs and you're selling 2 lakhs worth. Now, you got only a little bit of that 1.6 lakhs, you sold for two lakhs, you can now buy only for 1.6 lakhs. The other Rs. 40,000 you must put it from your bank account.

Deepak: Yes. You must find another 40K to buy. Put that and then place the buy order.

Vashistha: Tomorrow, that 40K will come and you must take it back out or just forget it and leave it in your brokerage account. So, you have a cash drag.

Deepak: Yes, you have a cash drag. And then you don't even realize what that cash drag is, because Smallcase doesn't know about it because they don't know why you have that cash in the bank.

Vashistha: Yeah, they don't know about the cash in your trading account. They just know about the stocks in your Smallcase.

Deepak: Correct, and that's perfectly fine, but that dilutes your personal return. So, if I invested 5 lakhs but I have five and a half lakhs of cash, what is my return? 5 or 5.5? A 14% will become a 12%. So, there are the small differences between what you can do with a Smallcase and what you can do in a PMS.

In a PMS, what you give us is what you've given us, regardless of whether we kept it as cash, stored it as momentum, it's a receivable, not reasonable, that is not your problem. We show you returns on the amount of cash you have.

Vashistha: Once you reach a particular size and we have clients on Smallcase who have like 20, 30, 40, or 50 lakhs.

Deepak: Some of them come back to us and tell us about this. How do you solve this?

Vashistha: Well, please give us the money. We will manage it because we can. We have the tools and resources to do it.

Deepak: And if this is not just for us to earn money, I mean the point is we're doing work so we will earn money when we do that. But the point is to ease effort, I mean.

Vashistha: And that product is not suitable for, like, a very large deployment.

Deepak: Yeah, it's not. It's fine because market orders vary. It's like saying you know, what is more efficient. At some point you want to own your own car. At some point you want to take public transport because you don't want the hassle of parking and finding something. And this and that and all that. Or you hire the services of a driver who will take care of all of this for you. Whichever way you do it, one of the ways I mean, one of the things that is clear is that a PMS will execute on your behalf

Vashistha: A Smallcase will make it easier, but it's still a headache to go and do it.

Deepak: Because if a stock is at lower circuit, it will not sell it and you will have to sell it manually if or if you want to wait till the lower circuit breaks, that could take 10 days.

Vashistha: Every day you must go and try to sell it. It might be that there might be a rebalance every Monday but there’s a lower circuit every day and you must go there and try.

Deepak: So, think of a PMS or the guy who's keeping on looking at the screen and saying, has the lower circuit broken. If it has, let’s go and sell. So, that's the thought process that's different between the two. But every PMS eases execution effort for you, and that's the job because they're the ones who are closest to the market. They know when volumes are moving up and down, and then they're able to execute.

Deepak: OK, we talked about mutual funds versus PMS. We're talking about Smallcase versus PMS. What about hedge fund or Cat-3 AIF?

Deepak: That's a very interesting point because Cat 3 AIFS comes closest. There's a difference between CAT3 AIFs and what we do as a PMS. The difference is CAT-3 AIFs are a pooled vehicle. You are sending the money into a single pool. The problem is, they don't get the taxation efficiency of a mutual fund. In fact, they get the taxation inefficiency of a pooled vehicle which is like a trust because in a trust where you'll get taxed on business income. I mean not just capital gains, but the business income is at 42.7%. So, there are some long short funds. AIFs can do this. Like I said, PMSes cannot leverage themselves. AIFs can leverage themselves to a factor of two to one. That means if we give them a hundred, they can bet on something worth 200. This is good, but this also means that on that leveraged part of the portfolio, which is typically done using features and options, you pay business income-based taxation, which is 42.7% and this is 42.7% from the 1st rupee you earn. No slabs. So, it’s 42.7% on the F&O part of things, which is what gives you the leverage and the same 10-15% on the stocks part of.

AIFs can do things like have lock-ins. They can have entry loads, exit loads, profit shares, all that stuff alongside. They can also do leverage, but they have this major tax disadvantage when they try to do leverage. They also have a very different form of functioning. They mean, they will still need a custodian. They will still operate using a broker. But they don't have the same level of transparency like we do in a sense in the PMS, so they can tell you your top 10 holdings. They can give you the whole thing but, in many cases, they won’t.

We're trying to deal with an AIF that's investing in real estate that literally refuses to tell you anything about where that money is invested right now. So, we're trying to, like, literally go down to saying, listen, we need to know something if you don't tell us anything, how are we going to even have the confidence that you have invested it in the right place? AIFs can be extremely secretive, which is why the minimum investment there is 1 Cr.

SEBI’s belief is if you are willing to give some fellow Rs. 1 Cr and on the basis that he may not reveal anything, you're either stupid enough to deserve to lose your money or you rich enough, or both. If you're rich we don't care.

It's fine because if you're rich enough to give somebody 1 Cr. and know that, then they have the ability to not tell you where your holdings are, then it's perfectly fine because you know, now you need to be rich enough to be able to lose that money. But in general, this kind of stuff doesn't happen in general. The AIFs are clean enough to, you know, give a nice picture.

Vashistha: But they still have their tax disadvantages, especially long short AIFs. And I think PMS-AIF World collates this list of performances for all the long-short tariffs, and it seems all of them end up underperforming the NIFTY.

Deepak: They say, don’t look at them on a one-year, three-year basis. Still, they seem to be not giving you as much performance as the NIFTY.

Vashistha: Yeah, no, though their drawdowns are lower, it's better risk adjusted returns. Again, the taxation has a huge drag.

Deepak: Yeah, I mean in a time like this, you don't care about risk adjusted returns. The concept of the AIF was that I want to be only 60% in equity, 40% in debt, that would make it return less on a good time. But if I am supposed to be fully invested, you're going to at some point of time, look at them for returns. But I mean, I think errors form a different kind of problem for a different kind of need. For instance, in AIFs (not sure if Cat-3 AIF can), you can invest in unlisted securities.

By the way, a PMS can’t even buy US stocks where we might like it, but we use an Indian ETF. Because we can only buy Indian listed mutual funds or stocks. An AIF can (not really, can buy private securities). They will say listen, I'll take your money and will go invest in the US. That's the difference between what an AIF can do and cannot. AIF can buy debt directly. Well, PMS can, if it's listed debt. It can't be unlisted debt. But now, because of SEBI rules, nobody is issuing unlisted debt. Very few people are, so as some of our friends in the industry will possibly see a negative consequence of, but I think the problem really is that you know we've created a vehicle called PMS, which is for people who can give 50 lakhs plus. Then we have created another vehicle called the AIF for who can give 1 Cr +. There are different levels of transparency, different levels of operations. In both cases you trust the manager of business, but the level of transparency mandated for our PMS is slightly higher.

Vashistha: So, the one advantage I can see for maybe a long time is AIF, do the same thing as a PMS but as an AIF is, they take care, because if they don't have any F&O, there's no high 42% taxation. There are only capital gains, but there the investor doesn't have to worry about advance taxes and so.

Deepak: Yes, and of course they still pay 42% tax on the dividends, but you know that hopefully you can. So, there are differences, and I think they're for different kinds of people. Sometimes we have enough customers who have invested both in the PMS (in our PMS) and other AIFs. And you know, many of these things; AIFs are also fancy, right? They are made by extremely intelligent people, and they have extremely focused portfolios. And like 5 stock portfolios that can last for 10 years, so there is no way you can even evaluate their performance before 10 years.

So, a lot of this is going to be in the future when we decide and look at it and say how long will it take for some of these AIFs to give you superlative returns? The same thing with PMSes. Aside, one of the things that we've seen is transparency helps. So even as an AIF, if we were to create one, we would like to be more and more transparent about the kind of returns.

Vashistha: Cool, so let's say it's already 2 1/2 hours I think, and we should close. So, let's end with. What do you think? What's the biggest value add we've done for customers?

Deepak: I think, discipline is the number one conceptual value add we've added to customers in the sense we said, you may be smart, maybe intelligence over, you know. So are a lot of people. But the difference between you and other people who may have the smarts but not have the discipline is that you'll end up better than them simply because you outsourced the discipline to somebody else. So, some people have chosen to do it through mutual funds. Some people have chosen. And do it through us, but in the process of earning their discipline, what we have given them is a clearer idea of how the whole thing operates. The transparency at which it operates, how their returns can be shown as a group in total with us, across different strategies and moving into debt, sometimes moving out of debt sometimes, and so on.

But doing this whole thing in a very low cost and efficient way while at the same time retaining a sense of community among, we promote camaraderie among customers, so that's some part of it is something that they learn. I think the value adds over here a lot of little things one of our customers told us today, here’s my returns now, but I think I've made more than this from just associating with you because there's so much more I've learned through this process. That's partly because they're also a member of Capitalmind Premium. But also, because the PMS process itself has gone through ups and downs and they've seen how momentum, for instance, went into cash during the big fall but index did not. The passive index was like listen, it is passive, we don't do anything. We just increased the amount of NASDAQ 100, which is a small call that we took but other than that there was nothing that changed for that. So that's a 35% decline whereas the momentum portfolio saw 10% decline.

So, they saw us through that operation. The second thing I think is the fact that a low-cost PMS can exist without a profit share and continue to grow.

Vashistha: Without distributors.

Deepak: Yes. Without distributors. I think that without the distributor it is quite interesting because many of our customers are used to distributors. We never thought we'd have like close to 500 crores of assets. I remember when we started this, we said that we put this in the business plan thing for the first year. We'll do 100 Cr, and in four years will be at 500 Cr. Today we have 482.

Like till today morning, and today the portfolios have gone up so it'll be higher tomorrow, but if you had told me in 2017 that in July 2021 will be at 482 Cr, I would have laughed you out the door because I would have said there is no way this is insane without distributors doing this. All offered using technology on our own from a little office in our layout which has become a big office. 

Vashistha: Not enough employees.

Deepak: I think I would have said this is impossible to do, but it's and I must thank all of our customers for this. They trusted us. They believed in us. Some of them looked at us and said, we've got substandard returns in the first few years. But we'll forgive you for it. And I thank them all for it. But we've come a long way and I hope they've gained through this process because we've been able to use momentum and the passive strategies to turn their portfolios around, some of whom have a 50% plus annualized return. It is mouth-watering and sometimes yeah, to be fair, that's not me and I haven't got those returns and keep looking.

Vashistha: Yeah, it depends when you enter and the timing and so on.

Deepak: I just basically use a systematic. The new mutual fund rules are that mutual fund employees must put 20% of their money into their funds. I put 50% of my income into our funds, I mean whatever I save, I literally throw into our funds. I'm happier to invest in our funds where I don't have to make any decisions for my own portfolio and I'm looking at things rather than anything else. I think that value add is possibly the biggest we've added that I think it's just that discipline, low cost.

Vashistha: I think I can give a bigger share of my overall network to this PMS. Otherwise, you'll say, yeah, I have two crores. I'll give 50 lakhs to this.

Deepak: Yeah, I think that is.

Vashistha: Here we have so many clients who have like 2-3 Cr net worth and they have a lot of it like 80% plus with us.

Deepak: Yes, and they and they're happy to see that some other portfolios in debt because they want it that way and some other portfolios in equity which are really targeted at the right moments of time. Hopefully and you know, we've seen COVID have a very, very rough impact on the economy and a lot of our customers have told us also, can we do something to help the economy? So, we might introduce more kinds of portfolios which allow people to do things like charity.

Through, of course. We are just the investing vehicle. They're the ones who want to do charity, but we will evolve as the world evolves and as new requirements come in, new products come in tomorrow. They're talking about accredited investors who can do investments of less than 50 lakhs. Who can do investments in private companies, in U.S. markets? I mean, the PMS rules get diluted for people who are accredited. You can bet that we will do the right things for our customers because we would love to. I mean our process is to do as much as you can for the customer. We also have a, you know, Capitalmind Premium.

Vashistha: Coupon, yes. If you have made it so far you can use the coupon, CMPODCAST and get a discount for Capitalmind Premium.

Deepak: Yes, Capitalmind.in, you can see the premium link on the right and please let us know that you have reached this far. Because we're counting, we know how many hits the podcast has gotten. The more you can tell us where we're at Capitalmind_in, Vashistha is at @uptickr, on Twitter and I am at @deepakshenoy on Twitter so please let us know. Capitalmind.in is where all the action is.

Vashistha: Since this is a PMS podcast, the PMS website is at Capitalmindwealth.com.

Deepak: Yes, Capitalwealth.com hopefully, as the new website evolves, we will not have to give you two different URLs, but on Capitalwealth.com, we have our portfolio disclosure document. None of this podcast was for investment advice. Don't think of any of the stocks in this podcast as advice for you to buy. And if you really feel the desire to buy stocks and do things yourself, there's Capitalmind Premium. If you feel the desire to say I want these guys to manage money, talk to us at least first before you make any decision, you know we're at Capitalmind Wealth. We are always available at your service.

Thanks for listening. This is a phenomenal podcast, longer than I thought it would be, but more fun to do than I thought it would be for something that explains the concept of a PMS.

Vashistha: Alright, thank you so much guys, bye.