Do PMS Performance Fees Push Managers to Chase Momentum?

Most investors read a PMS fee schedule as a price. It is also a contract that tells the manager which outcomes pay best. A fixed fee pays for assets gathered and kept. A performance fee pays for returns above a line on a particular date. Neither is neutral.

The question matters more as the industry grows. In an address to the industry on 30 September 2026, SEBI's chairman said portfolio managers' assets, excluding PF and EPFO money, had reached about ₹9.2 lakh crore by August 2026, with over 530 registered managers and around 2.2 lakh discretionary clients. In the same speech at the APMI Annual Conclave he listed the questions that should travel with any return figure: "What risks were taken to generate that return? What was the appropriate benchmark? How concentrated was the portfolio? What were the drawdowns? Was the performance consistent with the stated investment philosophy?"

This article asks a narrower version of those questions. Does the way a PMS manager is paid tilt them toward buying what has already gone up, crowding into the same stocks as peers, or taking more risk when they are behind?

Three ground rules apply throughout:

• Evidence and hypothesis are kept apart. Where a claim rests on a published study, the study is named. Where it rests on theory, it is labelled as theory.
• No manager is named. No citable research shows that any particular Indian portfolio manager chases momentum because of how they are paid.
• Momentum is not treated as a fault. A disclosed momentum strategy is a legitimate style. The concern is undisclosed drift toward it under fee pressure.

The agency problem arises whenever one person (the principal) hires another (the agent) to act for them, the two want different things, and the principal cannot see everything the agent does. A PMS mandate fits the description exactly. You hand over discretion, the manager knows far more about the portfolio than you do, and the manager's pay depends on the contract, not on your welfare.

The idea is older than the fund industry. A CFA Institute Research Foundation summary of the principal–agent literature traces it to Ronald Coase's examination of the firm in the 1930s, then to work in the 1950s and 1960s on contracts and on risk-sharing by economists including Robert Wilson and Kenneth Arrow. Those strands merged into what economists now call the principal agent problem.

Regulators noticed early. Kitces, a US adviser publication, recounts that the US Investment Advisers Act of 1940 banned most performance-based pay for advisers. A 1970 amendment allowed mutual funds only symmetric "fulcrum" fees, which fall for underperformance as much as they rise for outperformance. Hedge funds made the fixed fee plus incentive fee with a high water mark their standard contract. Indian PMS profit-sharing plans resemble that model.

SEBI did not ban asymmetric fees. It constrained them. SEBI's circular of 5 October 2010 on fees and charges brought in the high water mark for a PMS performance fee, and the principle now sits in the Master Circular for Portfolio Managers dated 16 July 2025.

On 24 September 2026 the SEBI Board approved a new set of Portfolio Managers Regulations for 2026. As of 5 October 2026 they do not appear on SEBI's list of notified regulations, so the 2020 Regulations and the 2025 Master Circular remain the rules in force.

A call option pays its holder when the price ends above a strike and pays nothing, but costs nothing more, when it ends below. A performance fee has the same shape. As the CFA Institute summary puts it, because the manager does not pay the investor back for losses, "the incentive fee is an option-like component of the management contract", while the fixed management fee is "an equity-like position" that grows with assets.

Option holders like volatility. A wider spread of outcomes raises the chance of a large payoff without adding any downside for the holder. Goetzmann, Ingersoll and Ross's study of high water marks, published in the Journal of Finance in 2003, valued the hedge fund contract this way. It found the fee to be a claim on "a significant proportion of investor wealth" and stated that "managers have an incentive to take risks".

The numbers below are illustrative, ignore the fixed fee, GST and costs, and are not drawn from any real strategy. Assume a ₹1 crore portfolio and a fee of 20% of gains above a 10% hurdle, charged once a year.

Both portfolios have the same expected return before fees. The volatile one pays the manager five times as much on average and leaves the investor with less. The table does not say managers will pick the volatile portfolio. It says the contract, taken alone, pays them more if they do.

Each date on which the fee is calculated and charged is an option expiry. More expiries mean more chances to collect on a temporary peak. The SEBI Master Circular for Portfolio Managers says that for charging a performance fee "the frequency shall not be less than quarterly", so charging can be quarterly, half-yearly or annual but not monthly, and that the fee must be computed on the high water mark principle "over the life of the investment".

The high water mark resets the strike. A portfolio that has dropped from ₹1 crore to ₹85 lakh must rise about 17.6% before any performance fee is payable again. That protects the investor from paying twice for the same gain, and it changes the manager's position.

Momentum chasing here means buying stocks mainly because they have risen recently, outside a disclosed momentum mandate. Theory suggests four channels through which pay could encourage it.

A manager well below the mark holds an option that is far out of the money. A cautious portfolio has little chance of reaching the strike within a year. A more volatile one has a better chance, and the manager loses no fee if it fails. Goetzmann, Ingersoll and Ross noted that the option-like features "could induce risk-taking behavior when the asset value is below the high-water mark". Recently strong, high-beta stocks are one way to add volatility quickly.

The fee is only part of the pay-off. The CFA Institute summary reports the finding that "the larger benefit to the manager comes from the additional fees" earned on the capital inflows that follow outperformance, and that investors "pour funds into recent sensational performers". If new money follows one-year rankings, a manager is paid twice for holding what is currently working: once through the performance fee and again through asset growth.

Chabot, Ghysels and Jagannathan make this argument in a 2014 NBER working paper on momentum crashes. They argue that managers who compete for return-chasing investors and earn convex fees have a reason to stay in momentum trades even when crash risk is elevated. Their evidence is historical return data plus a model, not a study of PMS managers. Separately, Brunnermeier and Nagel's study of the technology bubble found hedge funds "heavily invested in technology stocks" on the way up, though it does not attribute that to fee structure.

Herding means buying or selling what other managers are buying or selling. The standard survey, Bikhchandani and Sharma's IMF paper on herd behaviour in financial markets, lists three causes: imperfect information, concern for reputation, and compensation structures. Where pay or survival depends on performance relative to peers, holding what everyone holds is the safe choice.

When many managers buy the same recent winners, herding and momentum buying look alike from outside. This channel works through career risk, which applies to fixed-fee managers as well.

A manager comfortably above the hurdle a few weeks before the fee date has a reason to cut risk and protect the fee already earned. One who is just below it has a reason to add risk. Either way, the calendar starts to shape the portfolio.

The research below comes from US and European mutual funds and global hedge funds. None of it studies Indian PMS.

The most direct of these is Elton, Gruber and Blake's paper on incentive fees and mutual funds. Those funds, the authors found, "take more risk than non-incentive-fee funds on average" and "increase risk after a period of poor performance and decrease it after a period of good performance". Two caveats apply. The US funds studied charged symmetric fulcrum fees, not an asymmetric PMS-style fee. And the authors caution about causality: managers who believe in their own ability may choose incentive fees in the first place.

Hedge fund research, where the contract is closest to a PMS profit-sharing plan, is more reassuring than the theory suggests.

• Reputation bites. Brown, Goetzmann and Park's study of hedge funds and CTAs found that managers who did well in the first half of a year reduced volatility and poor performers increased it, and that excess volatility raised the chance of the fund closing. Their conclusion: "reputation costs have a mitigating effect on the gambling incentives implied by the manager contract".
• Long horizons calm the option. Panageas and Westerfield's paper on high water marks and risk appetite showed that when the contract has no fixed end date, "even risk-neutral managers will not place unboundedly large weights on the risky assets". A manager who blows up this year forfeits every future year's fee.
• High water marks and own money dampen risk-shifting. Aragon and Nanda (Review of Financial Studies, 2012) found that risk-shifting after poor performance was significantly weaker where the fund had a high water mark, faced low liquidation risk, and the manager had personal capital invested.

The classic study is Grinblatt, Titman and Wermers (American Economic Review, 1995). Looking at 155 US mutual funds from 1975 to 1984, it found that 77% were momentum investors that bought past winners, that those funds performed better on average, and that evidence of herding was relatively weak. Very few US mutual funds charged incentive fees, so momentum buying was widespread without any performance fee. Such a fee is one possible push among several, and no study isolates it as the main one.

Indian research on these questions is thin, and little of it concerns PMS.

Herding in Indian mutual funds. Patro and Kanagaraj of IIM Indore, writing in the Asian Journal of Finance and Accounting in 2012, measured herding in 30 Indian equity mutual funds. They reported strong herding, more pronounced on the buy side and in large-cap stocks.

Herding by foreign institutions. A 2023 study by Sahoo, Rajvanshi and Syamala of IIM Calcutta examined herding behaviour of institutional investors in India using foreign institutional trades from 2003 to 2021. It linked sell-side herding to later return reversals. These are foreign funds, not portfolio managers.

PMS returns and incentives. Aggarwal and Vadgama's 2022 paper in the Universal Journal of Accounting and Finance examined a small sample of PMS strategies and found that most failed to beat their benchmarks over short and medium periods. It does not test whether fee type changes what managers buy.

Momentum as a factor in India. NSE Indices' April 2026 paper on momentum reports that the Nifty200 Momentum 30 index returned 19.19% a year against 15.08% for the Nifty 200 from April 2005 to 27 February 2026, with a maximum drawdown of about 68% against 64%.

What the regulator's working group recorded. The 2019 report of SEBI's working group on portfolio managers listed among the issues raised that "benchmarks are not specified and are changed arbitrarily" and that "Performance fees are often calculated after taking only realised gains into consideration". Those are observations gathered in consultation, not findings of misconduct, and SEBI has since tightened the benchmark rules.

Where it runs out. We found no published, peer-reviewed study that compares the holdings, turnover or momentum exposure of Indian PMS strategies by fee plan. Any statement that Indian PMS managers chase momentum because of profit-sharing is therefore an inference from foreign evidence and from theory.

Several findings favour paying on performance.

• Better stock selection in the US sample. Elton, Gruber and Blake found that incentive-fee funds showed positive stock selection ability and charged lower expense ratios than comparable funds.
• Alignment features are linked with better results. Agarwal, Daniel and Naik (Journal of Finance, 2009) found that hedge funds with stronger manager incentives, including personal ownership and high water marks, performed better, while the fee percentage alone did not explain performance.
• A fixed fee has its own conflict. A simulation by Clare, Motson, Payne and Thomas of Cass Business School, summarised by CFA UK in 2015, concluded that a fixed percentage-of-assets fee was generally the best structure for the manager and the worst for the investor.

One finding cuts the other way. Servaes and Sigurdsson, in a 2018 ECGI working paper on European mutual funds, found that performance-fee funds delivered risk-adjusted returns about 0.50% a year lower than other funds, and that the gap came from funds whose fee was measured against no benchmark or an easy one. The lesson for a PMS investor is that the hurdle and benchmark matter as much as the percentage.

Several features of the Indian market push against the option incentive. None removes it.

Benchmark tagging. Under the Master Circular, each investment approach is tagged to a broad strategy and to one of a limited set of benchmarks prescribed by the industry body APMI. A manager who changes the strategy or benchmark must first offer clients an exit without exit load, and the earlier track record "shall not be used" in performance reporting after the change. That raises the cost of relabelling a portfolio after style drift.

The 2026 regulations. SEBI's press release on the Board meeting of 24 September 2026 says the approved regulations will permit investment in exchange-traded derivatives up to 1.25 times a client's assets. Wider limits would give an option-like contract more ways to add volatility. Whether managers use them that way is a hypothesis, and the rules were not yet notified at the time of writing.

Style drift means a portfolio moving away from the philosophy the manager described when you invested. Momentum chasing is one form of it. You cannot observe motives, but you can observe portfolios, and PMS holdings sit in your own demat account.

SEBI's monthly reporting format asks managers for a portfolio turnover ratio computed as the higher of purchases or sales in the month divided by average assets. Other conventions use the lower of the two, so ask which definition your manager quotes. Level matters less than change. A value-oriented strategy whose turnover doubles with no stated change in process deserves a question, as does heavy trading just before the performance fee is calculated.

Concentration is normal in PMS. What matters is what the portfolio is concentrated in, and how that changed. Compare holdings from four or eight quarters ago with today's. A quality-focused portfolio that now holds mostly the past year's strongest sectors shows style drift, whatever the factsheet says. SEBI's 2025 format for the PMS disclosure document requires managers to disclose concentration risk and conflicts of interest, so read those sections against the actual holdings.

A hurdle well below the long-run return of the equity market turns a performance fee into a fee for being invested. Check which benchmark the strategy is tagged to, whether it suits the stocks actually held, and whether it has ever changed.

• What was the strategy's turnover in each of the last three years, and on which definition?
• How far is the average client account from its high water mark today?
• Does the fund manager's own pay depend on this year's performance fee, on assets, or on a longer period?
• How much of the manager's own money sits in the strategy?
• Has the benchmark or stated investment approach changed since launch?

Checking a fee contract against a portfolio takes data from several places. PMS Sahi Hai puts much of the first layer on one screen, and its AI analyst Nyra helps with the reading.

Start with the contract terms. On the PMS Sahi Hai compare page you can filter strategies by category, fund house, benchmark, size or style and line up as many as four side by side. Individual strategy pages show the fee plan, including the performance fee and its hurdle, alongside the stated benchmark, number of holdings, volatility, maximum drawdown and the manager's tenure. That answers two questions before any meeting: is the hurdle demanding for this style, and has risk been high for the return?

Check consistency, not just the headline. Every strategy carries a Nyra Score from 0 to 10. The published Nyra Score methodology uses five pillars with fixed weights. Consistency (15%) measures how often the strategy beat its benchmark across horizons and how stable that outperformance was. Downside Protection (20%) covers maximum drawdown, volatility and beta. Fee alignment is one input within the Structure and Stewardship pillar. The score does not measure fund manager incentives or momentum exposure directly, and should not be read as doing so.

Look across what you already own. Nyra offers a portfolio review described on the site as covering "overlap, drift & fee drag across your holdings", and the portfolio health check lists manager tenure, the full fee load and overlap among its five areas. If two of your managers have moved into the same crowded stocks, overlap is where herding shows up in your own accounts.

Go deeper on the signals. The strategy pages do not publish turnover, so that figure still has to come from the manager. Our guide to portfolio turnover ratio in PMS explains the calculation, and the guide on concentration risk in PMS covers how many stocks is too few.

Two disclosures belong in an article about incentives. Nyra is, in the site's words, "an analytical tool, not a SEBI-registered Investment Adviser". And PMS Sahi Hai is an APMI-registered distributor paid by the fund house when you invest through it, as its fee disclosure page explains. That is an agency relationship too. The site's stated safeguard is that "no fee can move a score". Apply the same scepticism to us that this article asks you to apply to a manager.

Four cautions keep this argument honest.

• The evidence is foreign and dated. Most of the studies cited use US or European data from 1975 to the early 2010s. Indian PMS differs in client type, direct stock ownership and regulation.
• Selection is not causation. A confident stock-picker and a risk-tolerant client may find each other under a profit-sharing plan without the fee changing anyone's behaviour.
• You cannot see the manager's own pay. The fee you pay goes to the firm. How the firm pays the individual who picks stocks is rarely disclosed and may matter more than your fee plan.
• Investors are part of the loop. A CFA Institute analysis of chasing mutual fund performance found that over three-year lookbacks the worst-ranked US funds went on to beat the best, and concluded that "performance chasing is best avoided". Clients who hire last year's winner and fire last year's laggard create the pressure they then complain about.

Detection has limits too. High turnover, sector rotation or a concentrated book can each have a sound explanation. None proves that a manager is acting on fee pressure.

The agency problem cannot be designed away. The practical response is to choose the conflict you can monitor and then monitor it.

For a sophisticated investor that means four things:

1. Read the contract as a payoff diagram. Note the hurdle, the fee share, the charging frequency and the benchmark, and ask what kind of year pays the manager best.
2. Prefer features the research supports. A hurdle that is demanding for the style, annual over quarterly charging where offered, and meaningful manager capital in the strategy.
3. Track process, not just returns. Turnover, sector weights and new purchases reveal style drift before returns do.
4. Do not be the flow that rewards momentum chasing. Evaluate over a full cycle against the tagged benchmark, not on one-year rankings.

PMS Sahi Hai and Nyra can shorten the data-gathering for the first three of these, since fee terms, benchmark and drawdown sit on each strategy page.
Evidence, not suspicion, should drive the decision. On present evidence, performance fee incentives are a reason to ask better questions, not a reason to assume the worst of any manager.

Before you commit capital, put the fee annexure and the portfolio side by side. Write down the hurdle, the fee share, the charging dates and the tagged benchmark, and ask the five questions listed above. Repeat the holdings comparison once a year, and whenever your account sits well below its high water mark.

For a head start, compare PMS strategies on PMS Sahi Hai to see fee terms, benchmarks and drawdowns together, or ask Nyra to review your existing holdings for overlap, drift and fee drag. Nyra is an analytical tool, not a SEBI-registered investment adviser, so treat its output as research.

This article is for education only and is not investment advice. Investments in securities are subject to market risks. Research findings cited here describe the samples studied and may not apply to any particular portfolio manager.