PMS Fees and Charges – High Water Mark | Hurdle Rate | Exit Load

PMS fees are not published the way a mutual fund expense ratio is published. There is no single headline number. What a client pays is assembled from a management fee, a set of operational charges, brokerage at actuals, and in most mandates a performance fee that arises only when two separate conditions are met. SEBI leaves the management fee itself to the agreement, but caps several other components. This article sets out each component and works the performance fee calculation across four years.

Table of Contents

1. What Fees Can a Portfolio Manager Charge?
2. The Indicative Cost Heads
3. What SEBI Caps and What It Prohibits
4. What is a High Water Mark?
5. What is a Hurdle Rate?
6. Performance Fee Worked Across Four Years
7. Frequently Asked Questions

Check out NISM X Taxmann's Portfolio Management Services (PMS) Distributors, the official NISM workbook for the NISM-Series-XXI-A certification. It sets out the full cost architecture of a PMS mandate, the two-part disclosure document, the fifteen-point client agreement and the client's reporting entitlement, alongside the portfolio management process, performance measurement and the governing SEBI regulations.

1. What Fees Can a Portfolio Manager Charge?

The portfolio manager can charge an agreed fee for rendering portfolio management services. The exact nature of those fees and expenses forms part of the client agreement.

Regulation 22 requires that the quantum and manner of payment of fees and charges for each activity be stated in the agreement between the portfolio manager and the client. That applies whether the service is rendered directly or is outsourced. The activities the regulation names are investment management, advisory and transfer, and transaction costs, with specific reference to brokerage costs, custody charges and the like. The portfolio manager is required to take the client’s prior permission in this respect.

The disclosure document must also carry a brief explanation to help the investor understand the various costs an investor may bear, directly or indirectly.

Two further protections apply. A fee calculation tool must be provided to every client, and fee illustrations must be provided whenever a performance fee is charged. No additional fees or charges may be levied beyond those specified in the agreement.

2. The Indicative Cost Heads

The workbook gives an indicative list of six heads. Fees and expenses could vary depending on the asset class and the type of portfolio.

Cost head	What it covers
Investment management and advisory fee	A fixed fee, a return based fee, or a combination of both. Typically charged on actuals and reimbursed to the portfolio manager.
Custodian fee and depository fee	Opening and operation of dematerialised accounts, custody and transfer charges for shares, bonds and units, dematerialisation, and other charges connected with operating the depository accounts.
Registrar and transfer agent fee	Charges payable to registrars and transfer agents for effecting transfer of securities and bonds.
Brokerage and transaction costs	Brokerage and related transaction costs form part of the acquisition cost or sale realisation, and include securities transaction tax and stamp duty.
Certification, fund accounting and professional fees	Outsourced fund accounting, taxation, auditing and legal services, franking charges, affidavits, notarisations and courier costs incurred on the client’s behalf.
Out of pocket and incidental expenses	Day to day operating costs including statutory levies, telephone expenses, and the opening of bank, trading and demat accounts.

3. What SEBI Caps and What It Prohibits

By circular dated 13 February 2020, in partial modification of the 2010 circular on regulation of fees and charges, SEBI mandated four things.

No upfront fees. As provided in Regulation 22(11) of the PMS Regulations, no upfront fees shall be charged by portfolio managers, either directly or indirectly, to clients.

Brokerage at actuals. Brokerage is charged to clients as an expense, at actuals.

A cap on operating expenses. Operating expenses excluding brokerage, over and above the fees charged for portfolio management service, shall not exceed 0.50 per cent per annum of the client’s average daily assets under management.

A graded exit load. Where the client portfolio is redeemed in part or full, the exit load charged is capped as follows.

Period from date of investment	Maximum exit load
First year	3% of the amount redeemed
Second year	2% of the amount redeemed
Third year	1% of the amount redeemed
After three years	Nil

Portfolio managers also cannot impose a lock-in on a client’s investment. Early withdrawal is governed by the terms of the agreement, which must state the withdrawal fee both as a percentage and as an amount.

4. What is a High Water Mark?

The high water mark is the highest value that the portfolio or account has reached. The portfolio manager charges a performance based fee only on the increase in portfolio value in excess of the previously achieved high water mark.

The mechanism is easiest seen in three steps.

Suppose a client’s initial contribution is ₹1,00,00,000, which rises to ₹1,20,00,000 in the first year. A performance fee or profit share would be payable on the ₹20,00,000 return.

In the next year the portfolio value drops to ₹1,10,00,000. No performance fee is payable.

If in the third year the portfolio rises to ₹1,30,00,000, a performance fee is payable only on the ₹10,00,000 by which portfolio value exceeds the previously achieved high water mark of ₹1,20,00,000. It is not payable on the full ₹20,00,000 gain from ₹1,10,00,000 to ₹1,30,00,000.

The client does not pay twice for the same rupee of gain. That is the whole point of the mechanism.

5. What is a Hurdle Rate?

Profit sharing and performance related fees are usually charged upon exceeding a hurdle rate or benchmark specified in the agreement.

The hurdle rate sits alongside the high water mark rather than replacing it. Both gates must be cleared before a performance fee arises. A portfolio can exceed its previous high water mark and still generate no performance fee, if the excess falls short of the hurdle. Section 6 shows exactly that happening.

6. Performance Fee Worked Across Four Years

The following illustration is drawn from the SEBI FAQ dated 28 October 2020. The assumptions are a hurdle rate of 8 per cent, a performance fee of 20 per cent over the hurdle rate, a fixed fee of 1.5 per cent, brokerage of 0.20 per cent per annum and other expenses of 0.50 per cent. The performance linked fee and the fixed management fee are calculated annually, so the performance period is one year. Other expenses include custody and fund accounting charges and registrar and transfer agent fees. All figures are pre-tax.

Year	Opening value	Return on portfolio	Performance fee	Total charges	Closing value	High water mark carried forward
1	₹50,00,000	+40%	₹2,98,000	₹4,08,000	₹65,92,000	₹68,90,000
2	₹65,92,000	−25%	Nil	₹1,45,024	₹47,98,976	₹68,90,000
3	₹47,98,976	+50%	Nil	₹1,05,577	₹70,92,887	₹70,92,887
4	₹70,92,887	+40%	₹4,22,736	₹5,78,779	₹93,51,262	₹97,73,998

Read the four years in sequence and the mechanism becomes clear.

Year 1. The portfolio returns 40 per cent. Returns realised over the high water mark are 37.80 per cent and returns over the hurdle rate are 29.80 per cent. A performance fee of 5.96 per cent of the capital arises, being 20 per cent of the excess over the hurdle. That is ₹2,98,000. The investor’s overall return after all charges is 31.84 per cent.

Year 2. The portfolio loses 25 per cent. Returns over the high water mark are negative. No performance fee arises. The client still pays brokerage, other expenses and the fixed management fee, totalling ₹1,45,024. The high water mark stays at ₹68,90,000 and does not reset downward.

Year 3. The portfolio gains 50 per cent and closes at ₹70,92,887, above the ₹68,90,000 high water mark. Yet no performance fee arises. The gain over the high water mark is 2.94 per cent, which is 5.06 percentage points short of the 8 per cent hurdle. Clearing the high water mark alone is not enough.

Year 4. The portfolio returns 40 per cent from a base of ₹70,92,887. Returns over the high water mark are 37.80 per cent and over the hurdle 29.80 per cent, so a performance fee of ₹4,22,736 arises. Total charges for the year are ₹5,78,779 and the investor’s overall return is 31.84 per cent.

Two conclusions follow. A client who suffers a loss year does not pay a performance fee to be restored to where they started. And a client whose portfolio recovers only modestly above its previous peak may still pay nothing, because the hurdle applies to the excess and not to the gross return.

Distributors who need to model these outcomes for a prospective client can build the calculation in a spreadsheet. Ready-built calculators across direct and indirect tax sit on Taxmann’s Tools.

7. Frequently Asked Questions

Can a portfolio manager charge an upfront fee?

No. Under Regulation 22(11) of the SEBI (Portfolio Managers) Regulations, 2020, no upfront fees may be charged by portfolio managers, directly or indirectly, to clients.

Is there a cap on PMS charges?

Yes, on two components. Operating expenses excluding brokerage, over and above the portfolio management fee, cannot exceed 0.50 per cent per annum of the client’s average daily assets under management. Exit load is capped at 3 per cent, 2 per cent and 1 per cent of the amount redeemed across the first three years, and nil thereafter. The management fee itself is not capped; it is whatever the agreement provides.

What is the maximum exit load on PMS?

3 per cent of the amount redeemed in the first year, 2 per cent in the second, 1 per cent in the third, and nil after three years from the date of investment.

Can a PMS impose a lock-in?

No. Portfolio managers cannot impose a lock-in on a client’s investment. The terms of premature withdrawal are set by the agreement.

Does a high water mark alone trigger a performance fee?

No. Where the agreement also specifies a hurdle rate, the return must clear both. The Year 3 figures above show a portfolio exceeding its high water mark yet paying no performance fee, because the excess fell below the hurdle.

Must the client be given a fee calculator?

Yes. A fee calculation tool must be provided to all clients by the portfolio manager, and fee illustrations must be provided whenever a performance fee is charged.

Advising a client on a PMS mandate or reviewing a fee schedule? The complete regulatory position, including the disclosure document and the client agreement, is set out in NISM X Taxmann's Portfolio Management Services (PMS) Distributors. For a written opinion on a specific arrangement, see Taxmann Advisory.