Stock market regulator SEBI on Tuesday asked portfolio managers that profits of their schemes be computed only on the high water-mark' principle.

This means the portfolio managers can only charge fee (or share profit) based on the highest value that the portfolio has reached over the life of the investment.

For example, if a portfolio of Rs 10 lakh appreciates to Rs 12 lakh in the first year, a performance fee or profit sharing will be payable on Rs 2 lakh. In the next year if the portfolio value falls to Rs 11 lakh, no performance fee will accrue.

If the portfolio value goes up to Rs 13 lakh in the third year, the fee can be charged only on Rs 1 lakh (Rs 13 lakh-Rs 12 lakh). For the fourth year, the high water-mark' will become Rs 13 lakh.

The regulator has thus ensured that portfolio managers do not charge for loss recovery.

Portfolio managers have been advised to charge performance fees after adjusting the high water-mark' for interim contributions and withdrawals by clients.

However, the high water-mark principle' will apply only to discretionary and non-discretionary services and not for advisory services.

The SEBI directive follows complaints from portfolio management services' clients on the issue of lack of uniformity, clarity and transparency on computation of fees and charges by portfolio managers.

New norms to take effect from Nov 1

SEBI has mandated that the norms will be implemented from November 1 for fresh portfolio management services' clients.

For existing clients, the implementation will be from January 1.

The regulator has also specified that all fees and charges are to be levied on the actual assets under management (AUM) of every client.

In order to discourage portfolio managers from constructing highly leveraged portfolio structures, SEBI has put in a condition that in case of a discretionary portfolio manager, a client's liability should not exceed his investment with the portfolio manager.

Portfolio managers have been asked to comply strictly with this regulation.

The market regulator has also prescribed a standardised format of declaring fees and charges.

Providers of portfolio management services are now expected to provide details of fees and charges under three scenarios 20 per cent profit, no profit/no loss and 20 per cent loss to all clients.

This format enables a client to compute the indicative gain or loss on the funds he would be investing for a year.

Portfolio managers should send a letter on the applicability of the high-water mark' principle to clients and get their signature on the new fees and charges structure.

New clients are required to sign a document declaring that they have understood the fee structure.