DEMOCRATISING WEALTH MANAGEMENT OR DILUTING REGULATORY THRESHOLDS? ANALYSING SEBI’S PROPOSED MUTUAL FUND-ONLY PMS FRAMEWORK.

This post is authored by Sharad Dhruw, third-year B.A. LL.B (Hons.) student at Hidayatullah National Law University, Raipur.

Introduction

With India’s wealth management industry witnessing increasing demand for personalised investment solutions, the Securities and Exchange Board of India (“SEBI”) has come up with the concept of Mutual Fund-only Portfolio Management Services (“MF-PMS”) as a regulatory sweet spot between traditional mutual funds and traditional portfolio management services (“PMS”). The suggested structure aims to enable portfolio managers to create and administer personalized portfolios primarily through mutual funds with a lower investment threshold. This aligns with SEBI’s efforts to move towards a fairer and investor-friendly regulatory framework that ensures market access while protecting investors.

This blog examines the proposed MF-PMS scheme, its implications for the Indian portfolio management system and its impact on the investor. Firstly, it decodes the framework and its regulatory rationale. Secondly, it explores issues relating to fees, institutional requirements and conflicts of interest. Lastly, it proposes a calibrated way forward informed by international best practices.

Decoding the MF-Only PMS Framework

Firstly, the proposed MF-PMS framework is a paradigm shift from the current product-centric securities laws approach to a calibrated investor regime, where regulatory requirements are adjusted according to the investor’s level of sophistication and the degree of discretion exercised by the portfolio manager, rather than being determined solely by the type of investment vehicle, where the regulatory requirements are consistent with the sophistication of the investors, levels of investor discretion, and not simply the investment vehicle. The proposal also creates a new middle ground between the traditional MF and PMS, as it retains mutual funds as the underlying investment vehicle while allowing portfolio managers to exercise discretion over scheme selection, asset allocation and rebalancing for individual investors. Unlike traditional mutual funds, where investments are managed collectively within a scheme, traditional PMS involves individually managed portfolios with greater discretion exercised by the portfolio manager. MF-PMS therefore combines the regulated underlying structure of mutual funds with the personalised allocation and portfolio-management features of PMS, recognizing that investors who want more tailored wealth management services won’t always be able to fit into a model. This is in line with Section 11 and 11(2) of the SEBI Act, 1992, which calls upon SEBI to safeguard investors’ interests and regulate the securities market intermediaries. In particular, the proposed framework’s emphasis on disclosure, fiduciary responsibilities and regulation of the portfolio manager’s allocation decisions enables SEBI to expand access to personalised portfolio management while retaining safeguards against the risks arising from such discretion. Additionally, it also accompanies the Master Circular for Portfolio Managers, 2025, which brings all SEBI regulations for governance, disclosure, and investor protection for portfolio managers under one umbrella, and also acknowledges the necessity of a proportionate regulatory framework tailored to the evolving demands of India’s wealth management sector.

Secondly, the proposal radically changes the nature of portfolio management as an institutionalization of the allocation process based on a fiduciary model, where instead of the selection of individual securities, the function of portfolio management is reduced to the creation and constant optimization of diversified portfolios based on the regulated scheme of mutual funds and other permissible investment instruments. The portfolio manager is no longer only responsible for selecting securities, but for making sound decisions about asset allocation, asset rebalancing and asset investment as well. This change is particularly wide-ranging in the extent of fiduciary duties that will be imposed on portfolio managers in accordance with Regulation 21 of the Code of Conduct on the  SEBI (Portfolio Managers) Regulations, 2020, which mandates that they exercise due skill, care, diligence, and fairness while acting in the best interests of their clients. At the same time, the limited use of regulated MF schemes ensures that the governance, valuation, disclosure, and risk management protection for underlying investments provided in the SEBI (Mutual Funds) Regulations, 1996 remain in place. This regulatory trajectory is continued which introduces provisions to enhance disclosure and digital onboarding requirements, reinforcing a broader shift towards a transparency-driven fiduciary approach to regulation as opposed to one-off product-based regulation.

Thirdly, the proposed framework is clearly a measure of financial inclusion, as the proposed reduction in the minimum investment threshold from Rs. 50 lakhs to Rs. 25 lakhs would enable a wider class of investors to access discretionary portfolio management services but also increases SEBI’s duty to ensure that such expanded access does not expose less sophisticated investors to risks they may not adequately understand. The reduction in the investment threshold addresses the barrier of entry to discretionary portfolio management; it does not, however, imply that investors newly able to access the service possess a corresponding level of financial sophistication. Access to markets, therefore, needs to be broadened hand-in-hand with improved suitability evaluations, clear disclosures, and proper handling of conflicts of interest so that increased accessibility is accompanied by safeguards proportionate to the level of discretion exercised by the portfolio manager. This approach is consistent with the Markets in Financial Instruments Directive II ("MiFID II"), which requires investment firms to undertake suitability and appropriateness assessments in the circumstances prescribed under the framework before providing investment advice or services. The proposed MF-PMS regime, hence, represents not merely an expansion of access to discretionary portfolio management, but an opportunity to calibrate regulatory requirements to the broader investor base that the lower threshold may bring within its scope.

Challenges in the proposed MF-PMS Framework.

Firstly, the proposed MF-PMS framework may create a fee-value mismatch. The MF-PMS manager would mainly be responsible for the scheme selection and asset allocation, whereas the underlying mutual-fund manager would be responsible for security selection as per conventional PMS. The investor would then be charged a PMS fee in addition to their costs in the underlying funds. While the suggested 2.5% cap offers a regulatory cap, the potential for performance-based remuneration becomes more challenging as the returns from the portfolio cannot be attributed solely to the MF-PMS manager. The issue is not only about the quantum of fees, but whether the extra levels of management provide equal value to investors and cost. This is especially important in areas where investors might have the ability to create their own diversified mutual-fund holdings with significantly less expense.

Secondly, the proposed relaxation of institutional requirements could create an imbalance in protecting investors under discretionary management. As the minimum investment threshold comes down from Rs. 50 lakhs to Rs. 25 lakhs and minimum net worth from Rs. 5 crores to Rs. 2 crores, the MF-PMS could potentially be made available to more investors. The framework is, however, a departure from security selection to scheme selection, asset allocation and rebalancing, and the manager’s fiduciary discretion remains intact even with a more limited universe of investment options. This results in a regulatory dilemma where regulated mutual funds offer underlying governance and risk-management protections, but not protections against risks that stem from the manager’s allocation choices. SEBI should therefore ensure that the institutional, compliance and risk management protections required for discretionary MF-PMS management are not watered down by the impositions of proportional regulation.

Thirdly, the framework is not necessarily suitable for resolving product-selection conflicts as the choice of investment products is replaced by the investment weights in the MF-PMS. However, even if underlying funds are regulated, conflicts can still occur when constructing portfolios. The winding up of six debt schemes in 2020 by Franklin Templeton has demonstrated that diversification of schemes and across schemes does not eliminate the concentration of risk and liquidity risk. Each scheme may appear to be diversified but the exposure to sectors or securities may overlap. The main challenge, therefore, is to make sure that the regulation of the underlying investment product does not take the place of the regulation of the intermediary’s selection of the investment product.

Conclusion and Way Forward

The proposed MF-PMS framework is an important initiative towards filling the regulatory void between mutual funds and traditional PMS. However, its success will be based on whether there are increased barriers to entry alongside specific controls targeting the risks of deliberate scheme choice. SEBI should thus introduce a risk-based approach instead of merely adapting the existing concept of PMS or significantly easing the PMS requirements.

Firstly, SEBI should implement a mechanism to allocate performance fees to the respective investors. Performance-linked remuneration ought to be based on a benchmark, most obviously the permitted investment universe, and should be paid only if the performance can be shown to be a direct result of the manager’s asset allocation decisions. Performance-linked remuneration ought to be based on a benchmark, most obviously the permitted investment universe, and should be paid only if the performance can be shown to be a direct result of the manager’s asset allocation decisions by comparing the actual portfolio performance with the performance of a pre-disclosed reference allocation across the permitted investment universe, thereby isolating the contribution arising from the MF-PMS manager’s scheme-selection and allocation decisions from returns generated by the underlying mutual-fund managers. There should also be a high-water mark at the individual client-portfolio level, such that performance fees would become payable only when the portfolio exceeds its previous highest value at which a performance fee was crystallised, and recovery of losses up to that level would not generate a further performance fee to ensure that the recovery for past losses is not repeated. This could align with IOSCO’s focus on clear fee structures and on the elimination of remuneration arrangements that foster inappropriate risk-taking. SEBI could also mandate disclosure of the performance contribution attributable to the MF-PMS manager’s asset-allocation decisions, alongside the overall portfolio return and an appropriate benchmark, which would allow investors to assess whether the incremental performance generated through the additional layer of PMS justifies the fees charged for the service.

Secondly, the easing of the institutional requirement needs to be translated into a graduated compliance model. SEBI could gradually increase the compliance requirement based on the AUM, clients, and complexity of the portfolio managed by an MF-PMS provider. Smaller managers may be better served with fewer requirements from an infrastructure perspective; larger managers, however, would need independent risk-management, compliance and internal-audit departments. This is the principle of proportionality as enshrined in MiFID II, which correlates the needs of the institution with the nature, scale and complexity of investment activities, which could allow regulators to enter smaller sized organisations but not let asset size increase without commensurate institutional capacity.

Thirdly, SEBI should introduce the concept of portfolio-level monitoring of conflicts of interest and concentration risks. Where MF-PMS providers offer significant look-through exposure, they must be required to disclose it for selected schemes and have documented policies for scheme selection, especially if they have affiliated AMCs or have distribution relationships. A model could be used whereby firms identify and manage any conflicts that might arise due to product selection, remuneration and inducements by conducting a portfolio-level assessment of each selected scheme, including its underlying issuer and sector exposures, its overlap with other schemes held in the portfolio, and any affiliation or distribution relationship, with material conflicts or concentration levels requiring documented justification and disclosure to the investor, as required by ESMA’s product-governance and conflict-of-interest frameworks, which would ensure that regulation follows the point at which discretion is exercised, and diversification at the scheme level does not hide concentration at the underlying-asset level.