HDFC AMC might list
high, but the time for a fat-fee AMC business is over
With the changing composition of inflows to mutual funds, ETFs
will grow because they mirror the performance of broad-based indexes, and are
very cost-efficient for the investor.
The grim irony of investing, then, is that we
investors as a group not only don't get what we pay for, we get precisely what
we don't pay for. So if we pay for nothing, we get everything. John Bogle, founder of
Vanguard Mutual Fund known for its low-cost funds
Saturday night was party time for those who got allotment for
the HDFC Asset Management Company (AMC) initial public offering (IPO). Some
planned to sell their holding on listing. Others saw it as an ultimate
wealth-compounding machine. But there was also a lot of disappointment as a
majority of applicants didn’t get any allotment. The issue was oversubscribed
83 times.
“In our family, seven of us applied for the HDFC AMC IPO. And none of us got any allotment,” says Harsh Khatri, a telecom-shop owner in Mumbai. It has been a long time since he had applied for an IPO with so much excitement. Nevertheless, he expects the IPO to list at INR1,400.
The AMC has offered 25.46 million shares in a price band of INR1,095-INR1,110 per share.HDFC and Standard Life Investments have sold their stake in the offer for sale, bringing it down to 82.94% from 94.95%.
While the interest around a brand name like HDFC is well understood, many feel that the HDFC AMC offer is expensive and the story around the asset-management industry in the country as a cash-generating machine has holes.
At a very basic level, HDFC AMC is valued at a price/book (PB) value of 10 times. Top banks in India trade at a PB value of 5 times with return on equity (ROE) of approximately 16%. HDFC AMC, on the other hand has an average ROE of 40%.
The other big AMC to have got listed in the recent times is Reliance Nippon. Its IPO was launched in November 2017 and was oversubscribed 81.54 times. At the time of the listing, the company had an 11% market share and was valued at INR15,442 crore, or 6.8% of its assets.
HDFC AMC’s market share of asset under management (AUM) is 13%, and for actively managed equity AUM the number is 17%. The company is valued at INR23,530 crore, or 7.6% of its AUM.
Both Reliance Nippon and HDFC AMC are similar in terms of revenues. HDFC AMC has a net profit margin of 38% and Reliance Nippon has a net profit margin of 28% for FY18. The ROE of Reliance Nippon is lower at 23%, or half that of HDFC AMC.
The larger question is whether such high RoEs for mutual-fund AMCs are sustainable
The short answer is no.
The way the world of investing is changing, with the rise of passive investing, such rich valuation of AMCs may be a short-lived phenomenon.
Globally, 6% of the total assets are now being managed through the exchange traded fund (ETF) route, and this is the fastest-growing segment of the market. If seen over the last 20 years, the active segment is growing at 4% and ETFs are growing at 25% per annum in the US market. Active funds find it difficult to beat benchmark indexes. The markets have noticed this.
Reliance Nippon itself listed at INR295 or 17% over the issue price. After one year, the stock has not moved and is trading closer to its IPO price. During the same period, Nifty 50, the benchmark index, has moved up 8%.
The investing community thinks HDFC AMC will list 17% over its issue price for sure. But the same investors who like the AMC business, want to give a premium to the brand and promoters while discounting the same for Reliance Nippon.
Without getting drawn in by the short-term spurt in prices, how should long-term investors look at the AMC businesses?The evolution of the AMC business holds a clue
The total AUM for the mutual-fund industry works out to INR22.86 lakh crore (or USD336 billion). The industry is on a growth path and on an average receives around INR6,000 crore through systematic investment plans (SIP) every month. In June 2018, INR7,554 crore came in.
The industry feels this is sticky money: Investors who start SIPs normally do not stop unless the market sees a serious correction. Their assumption is that the Indian equity markets will not have any serious corrections. Much of the industry doesn’t believe in black-swan events. Those who believe in them do not have the AUM.
The biggest pitch that the Indian AMC industry has given to the world is the fact that AUMs account for only 11% of the gross domestic product (GDP) for India. For a country like the US, it is 101%. This means India has a long way to go.
In 1993, AUMs accounted for 5% of the GDP, when there were no private players in the business and UTI was the leader. Over the years, the GDP has gone up, and so have AUMs. So, from here on, AUMs are expected to grow at a faster rate.
According to CRISIL Research, AUMs will grow from INR20.6 lakh crore as of March 2018 to INR 48.4 lakh crore by March 2023, clocking an annual growth rate of 18.6%. Equities will grow at 22.3%, much faster than the overall growth. Equities account for 40% of the total assets of the industry. AMCs charge around 2% on 30% of the AUM as almost 10% belongs to the ETF business, which generates low income for the AMCs.
The ETF business is also growing very fast
What has not been factored into all these projections is the changing composition of fund flows to mutual funds.
In future, it is the ETF part of the business that will grow. ETFs mirror the performance of broad-based indexes like the Nifty 50 or the BSE Sensex. They are very cost-efficient for the investor, and as markets become efficient, it becomes extremely difficult to beat ETFs.
Indian AMCs have stayed away from ETFs and index funds because of their low contribution to profits.
Quietly, SBI Nifty ETF has achieved a size of INR35,000 crore. This is because the Employee Provident Fund Office is now allowed to invest up to 15% of its funds in equities. They do it through the SBI Nifty 50 ETF.
What is even more interesting is the that SBI ETF has an expense ratio of just 7 basis points (0.07 percentage points). Active funds have a cost of 200 basis points.
Get paid for underperformance
So, this is the 30x extra money that the active funds collect to outperform the market. Nothing wrong with that. Now look at the performance data.
Majority of the large-cap funds find it difficult to deliver alpha (excess returns over the benchmark returns) or beat the Nifty 50. According to research house Morningstar India, 76% of the AUMs delivered less returns than the benchmark indices over the last one year, and 60% underperformed the indices over the last three years.
The biggest large-cap and multi-cap funds in the industry belong to HDFC Mutual Fund, and each of these charges an expense ratio of around 2%.
HDFC Equity, a multi-cap fund, with total assets of around INR20,352 crore, charges an expense ratio of 1.96%. The fund is underperforming the Nifty 500 for the last three years.
HDFC Top 100 fund, a large-cap fund, which charges an expense ratio of 2.05%, has total assets of INR14,376 crore. Again, the fund is underperforming the Nifty 100 for the last three years.
Equity-oriented schemes account for 50% of the overall AUM of HDFC AMC and a bulk of its revenue. According to Morningstar India, 60% of the equity AUM of HDFC AMC has underperformed on a one-year basis, and 87% of the AUM has underperformed on a three-year basis.
As the size of these equity funds increases, the underperformance grows. How long will Indian investors knowingly stay with underperforming funds? While SIP is sticky money, beyond a point, distributors and advisors will be forced to move this money into assets that are productive.
The US witnessed the shift after credit crisis
In the US market, investors moved to ETFs and index funds after the financial crisis of 2008. At that time, these categories accounted for around USD500 billion of investment. Over the next 10 years, these passive funds moved up by 10 times, to USD5,000 billion in 2017.
In the next three years, India might face a similar situation when investors start questioning their advisors or distributors.
“If the market even remains flat or there is a serious correction, then investors will question. SIPs will stop,” says the founder CEO of a fund.
In general, AMC is a tough business to run for smaller funds as distributors have limited shelf space. They are comfortable with India’s best-known brands. Smaller funds have to perform and spend a lot on marketing.
“I have been in this business for the last two decades and I have seen this business change all the time. The only thing that has helped some of the AMCs is the regulatory environment in India and the brand power that some banks enjoy in this country. It is not an easy business for small companies,” says Sanjiv Shah, who started Benchmark Asset Management Company in 2000, which specialised in ETFs and was a pioneer of this format in India.
Shah points out that over the last few years, all the foreign-owned AMCs in India have moved out of the country by selling their businesses to their Indian counterpart because they found it difficult to make money in the Indian market.
In India, one needs to have a huge marketing budget to keep distributors happy. Distributors understand the individual psyche of the retail investor and rope in these investors into SIPs for as long as 10 years. But then they ask for a high fee for this sticky money.
“Mutual-fund distribution will and is already undergoing a lot of change with the advent of technology. The expansion of technology coupled with the entry of millennials into the market have created a perfect storm calling for a constant evolution,” says Navin Chandani, chief business development officer at BankBazaar.com.
Distributors so far have hesitated to sell index products as they are not lucrative. Consider ICICI Prudential’s Nifty Next 50 index fund with a corpus of INR246 crore. The fund has never actively sold this scheme to investors and the bulk of its sales have happened through the direct plan. It is a fund that has topped the ranking for years. But only the most suave investors have opted for the fund. This fund has a low expense ratio and doesn’t really add much to the profits of the AMC.
But now this is what is putting all the AMCs into a catch-22 situation. The best products (ones that delivers benchmark indices-matching returns) are low cost but they don’t mean much to the AMCs’ profits. This mirrors what is happening in other markets, too.
Fidelity Investments is introducing a zero-cost index fund. Vanguard, a fund house known for low-cost products, is offering free trading of ETFs. Smart beta funds are available at 20 basis points.
Since 2000, mutual funds in the US have seen an annual growth of 6.2% in terms of AUM. Of this, active funds have grown by 4.8%. Index funds have grown 12.8%, and ETFs have grown by 25.3%. ETFs cost around 0.16% in the US market.
Sure, India may be a few years away from this, but with the rise of technology platforms and financial savviness of investors, the AMC business is going even tougher. Investors will move to those who offer low-cost and superior returns.
(Disclaimer: The writer owns 95 shares of Reliance Nippon AMC.)
“In our family, seven of us applied for the HDFC AMC IPO. And none of us got any allotment,” says Harsh Khatri, a telecom-shop owner in Mumbai. It has been a long time since he had applied for an IPO with so much excitement. Nevertheless, he expects the IPO to list at INR1,400.
The AMC has offered 25.46 million shares in a price band of INR1,095-INR1,110 per share.HDFC and Standard Life Investments have sold their stake in the offer for sale, bringing it down to 82.94% from 94.95%.
While the interest around a brand name like HDFC is well understood, many feel that the HDFC AMC offer is expensive and the story around the asset-management industry in the country as a cash-generating machine has holes.
At a very basic level, HDFC AMC is valued at a price/book (PB) value of 10 times. Top banks in India trade at a PB value of 5 times with return on equity (ROE) of approximately 16%. HDFC AMC, on the other hand has an average ROE of 40%.
The other big AMC to have got listed in the recent times is Reliance Nippon. Its IPO was launched in November 2017 and was oversubscribed 81.54 times. At the time of the listing, the company had an 11% market share and was valued at INR15,442 crore, or 6.8% of its assets.
HDFC AMC’s market share of asset under management (AUM) is 13%, and for actively managed equity AUM the number is 17%. The company is valued at INR23,530 crore, or 7.6% of its AUM.
Both Reliance Nippon and HDFC AMC are similar in terms of revenues. HDFC AMC has a net profit margin of 38% and Reliance Nippon has a net profit margin of 28% for FY18. The ROE of Reliance Nippon is lower at 23%, or half that of HDFC AMC.
The larger question is whether such high RoEs for mutual-fund AMCs are sustainable
The short answer is no.
The way the world of investing is changing, with the rise of passive investing, such rich valuation of AMCs may be a short-lived phenomenon.
Globally, 6% of the total assets are now being managed through the exchange traded fund (ETF) route, and this is the fastest-growing segment of the market. If seen over the last 20 years, the active segment is growing at 4% and ETFs are growing at 25% per annum in the US market. Active funds find it difficult to beat benchmark indexes. The markets have noticed this.
Reliance Nippon itself listed at INR295 or 17% over the issue price. After one year, the stock has not moved and is trading closer to its IPO price. During the same period, Nifty 50, the benchmark index, has moved up 8%.
The investing community thinks HDFC AMC will list 17% over its issue price for sure. But the same investors who like the AMC business, want to give a premium to the brand and promoters while discounting the same for Reliance Nippon.
Without getting drawn in by the short-term spurt in prices, how should long-term investors look at the AMC businesses?The evolution of the AMC business holds a clue
The total AUM for the mutual-fund industry works out to INR22.86 lakh crore (or USD336 billion). The industry is on a growth path and on an average receives around INR6,000 crore through systematic investment plans (SIP) every month. In June 2018, INR7,554 crore came in.
The industry feels this is sticky money: Investors who start SIPs normally do not stop unless the market sees a serious correction. Their assumption is that the Indian equity markets will not have any serious corrections. Much of the industry doesn’t believe in black-swan events. Those who believe in them do not have the AUM.
The biggest pitch that the Indian AMC industry has given to the world is the fact that AUMs account for only 11% of the gross domestic product (GDP) for India. For a country like the US, it is 101%. This means India has a long way to go.
In 1993, AUMs accounted for 5% of the GDP, when there were no private players in the business and UTI was the leader. Over the years, the GDP has gone up, and so have AUMs. So, from here on, AUMs are expected to grow at a faster rate.
According to CRISIL Research, AUMs will grow from INR20.6 lakh crore as of March 2018 to INR 48.4 lakh crore by March 2023, clocking an annual growth rate of 18.6%. Equities will grow at 22.3%, much faster than the overall growth. Equities account for 40% of the total assets of the industry. AMCs charge around 2% on 30% of the AUM as almost 10% belongs to the ETF business, which generates low income for the AMCs.
The ETF business is also growing very fast
What has not been factored into all these projections is the changing composition of fund flows to mutual funds.
In future, it is the ETF part of the business that will grow. ETFs mirror the performance of broad-based indexes like the Nifty 50 or the BSE Sensex. They are very cost-efficient for the investor, and as markets become efficient, it becomes extremely difficult to beat ETFs.
Indian AMCs have stayed away from ETFs and index funds because of their low contribution to profits.
Quietly, SBI Nifty ETF has achieved a size of INR35,000 crore. This is because the Employee Provident Fund Office is now allowed to invest up to 15% of its funds in equities. They do it through the SBI Nifty 50 ETF.
What is even more interesting is the that SBI ETF has an expense ratio of just 7 basis points (0.07 percentage points). Active funds have a cost of 200 basis points.
Get paid for underperformance
So, this is the 30x extra money that the active funds collect to outperform the market. Nothing wrong with that. Now look at the performance data.
Majority of the large-cap funds find it difficult to deliver alpha (excess returns over the benchmark returns) or beat the Nifty 50. According to research house Morningstar India, 76% of the AUMs delivered less returns than the benchmark indices over the last one year, and 60% underperformed the indices over the last three years.
The biggest large-cap and multi-cap funds in the industry belong to HDFC Mutual Fund, and each of these charges an expense ratio of around 2%.
HDFC Equity, a multi-cap fund, with total assets of around INR20,352 crore, charges an expense ratio of 1.96%. The fund is underperforming the Nifty 500 for the last three years.
HDFC Top 100 fund, a large-cap fund, which charges an expense ratio of 2.05%, has total assets of INR14,376 crore. Again, the fund is underperforming the Nifty 100 for the last three years.
Equity-oriented schemes account for 50% of the overall AUM of HDFC AMC and a bulk of its revenue. According to Morningstar India, 60% of the equity AUM of HDFC AMC has underperformed on a one-year basis, and 87% of the AUM has underperformed on a three-year basis.
As the size of these equity funds increases, the underperformance grows. How long will Indian investors knowingly stay with underperforming funds? While SIP is sticky money, beyond a point, distributors and advisors will be forced to move this money into assets that are productive.
The US witnessed the shift after credit crisis
In the US market, investors moved to ETFs and index funds after the financial crisis of 2008. At that time, these categories accounted for around USD500 billion of investment. Over the next 10 years, these passive funds moved up by 10 times, to USD5,000 billion in 2017.
In the next three years, India might face a similar situation when investors start questioning their advisors or distributors.
“If the market even remains flat or there is a serious correction, then investors will question. SIPs will stop,” says the founder CEO of a fund.
In general, AMC is a tough business to run for smaller funds as distributors have limited shelf space. They are comfortable with India’s best-known brands. Smaller funds have to perform and spend a lot on marketing.
“I have been in this business for the last two decades and I have seen this business change all the time. The only thing that has helped some of the AMCs is the regulatory environment in India and the brand power that some banks enjoy in this country. It is not an easy business for small companies,” says Sanjiv Shah, who started Benchmark Asset Management Company in 2000, which specialised in ETFs and was a pioneer of this format in India.
Shah points out that over the last few years, all the foreign-owned AMCs in India have moved out of the country by selling their businesses to their Indian counterpart because they found it difficult to make money in the Indian market.
In India, one needs to have a huge marketing budget to keep distributors happy. Distributors understand the individual psyche of the retail investor and rope in these investors into SIPs for as long as 10 years. But then they ask for a high fee for this sticky money.
“Mutual-fund distribution will and is already undergoing a lot of change with the advent of technology. The expansion of technology coupled with the entry of millennials into the market have created a perfect storm calling for a constant evolution,” says Navin Chandani, chief business development officer at BankBazaar.com.
Distributors so far have hesitated to sell index products as they are not lucrative. Consider ICICI Prudential’s Nifty Next 50 index fund with a corpus of INR246 crore. The fund has never actively sold this scheme to investors and the bulk of its sales have happened through the direct plan. It is a fund that has topped the ranking for years. But only the most suave investors have opted for the fund. This fund has a low expense ratio and doesn’t really add much to the profits of the AMC.
But now this is what is putting all the AMCs into a catch-22 situation. The best products (ones that delivers benchmark indices-matching returns) are low cost but they don’t mean much to the AMCs’ profits. This mirrors what is happening in other markets, too.
Fidelity Investments is introducing a zero-cost index fund. Vanguard, a fund house known for low-cost products, is offering free trading of ETFs. Smart beta funds are available at 20 basis points.
Since 2000, mutual funds in the US have seen an annual growth of 6.2% in terms of AUM. Of this, active funds have grown by 4.8%. Index funds have grown 12.8%, and ETFs have grown by 25.3%. ETFs cost around 0.16% in the US market.
Sure, India may be a few years away from this, but with the rise of technology platforms and financial savviness of investors, the AMC business is going even tougher. Investors will move to those who offer low-cost and superior returns.
(Disclaimer: The writer owns 95 shares of Reliance Nippon AMC.)
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