Should you invest in Asset Management Companies?
Rapid Reading: Bank deposit rates in India are at a multi-year low. Falling interest rates and resurgence in equity markets have created an ideal scenario for asset managers to lap up the growth opportunities. India’s Assets under Management (AUM) to GDP ratio is merely 12% vis-à-vis the global average of 55%. With growing awareness and financialization of savings, Asset Management Companies (AMCs) might capture a greater piece of the retail savings pie in future. The moot question is will they make interesting investments too? Bigger fund houses may have an edge over others.
We’re not thinking about raising rates. We’re not even thinking about thinking about raising rates. What we’re thinking about is providing support for the economy. We think this is going to take some time—Jerome Powell, Federal Reserve (Fed) chairman.
Recessionary pressure and continuing uncertainty pertaining to COVID-19 has depressed interest rates globally. Interest rates are likely to stay low across the globe at least for the next two years. Will inflation follow the same path? That’s where expert haven’t formed any consensus yet.
India isn’t an exception to this phenomenon. As RBI has aggressively lowered the repo rates since the coronavirus pandemic outbreak, banks have moved swiftly to cut interest rates on deposits. As a result, the weighted average interest rate on deposit has crashed to a multi-year low in India.
Today, banks are awash with cash and there aren’t adequate lending opportunities—a phenomenon last observed post demonetization in 2017. Weighted average interest rates have dropped further to 5.5% in June. On the other hand, equity indices have shot up over 30% from their March lows. Will lower interest rates and stable equity markets push more investors towards mutual funds?
Less than 5% of Indians invest in mutual funds and according to AMFI data, there are just 3.2 crore Systematic Investment Plan (SIP) accounts in India.
Interestingly, Assets under Management (AUM) of mutual funds has doubled in the last 5 years and has gone up 3 times over the last 10 years. As on May 31, 2020 Industry AUM stood at Rs 24.55 lakh crore.
Will lower interest rates bring in changes in investors’ preferences? Fears and slowdown and job market uncertainty may dissuade investors from investing in real estate—that being a high-ticket investment avenue.
We need to dwell deeper to take any guess on the future of this trend.
What does the immediate future look like?
In the absence of private sector capex, the government will be forced to pump in more money in the economy, and may even have to borrower more for that purpose. Therefore, the government would like interest rates to stay lower. So is the case with capital intensive industries, and industries already burdened with a huge debt pile.
Asymmetry between global interest rates and domestic interest rates can also lead to export uncompetitiveness as it creates an upward pressure on the country’s currency. Therefore, inflation expectation is the key.
As you might be aware, policy rates in India are closely tied up with inflationary trends. RBI is working with an intermediate inflation target of 4% with +/-2% margin for error. In other words, as long as the retail inflation stays in the range of 2% and 6%, interest rates in India too are unlikely to go up.
How might investors approach falling interest rates?
It’s painful to see nominal interest rates on deposits going down, especially for the senior citizens. If the cost of living and food inflation stays higher in urban areas, Dosanomics—a doctrine that advocates that the real interest rates matter more than nominal interest rates—is unlikely to work for the majority of investors.
Flexibility in asset allocation would be crucial…
Flexibility in asset allocation may allow investors to take advantage of volatile market conditions and increase allocations to equity assets. For instance, an investor with a target asset allocation 20%-30% in fixed income instruments might want to keep the allocation to fixed income assets near the lower end of the spectrum, given that the interest rates are falling. There too, investors might prefer debt funds as bond prices and interest rates share an inverse co-relation.
Post the Franklin Templeton Mutual Fund episode—wherein the fund house discontinued 6 debt funds abruptly—investors have been cautious. However, some leading mutual funds have clarified their investment stance and assured investors of following the best investment practices—a major lapse that led to some of the recent fiascos.
As remains the equity allocation, investors have been remarkably resilient. The number of retail accounts has risen for the 72nd consecutive month in May 2020. Despite the market mayhem of March 2020, mutual fund houses have collected Rs 16,500 crore in April and May through SIPs.
Nitty-gritties of asset management business
Just like Metals, Autos and Banking, the business of asset management is also cyclical to a large-extent. AUMs swell when the market conditions are upbeat and vice-versa. Profits are linked to the AUM. Fund houses having a sound track-record of performance always have an edge over others. Economies of scale add to the profitability, simply because fixed costs don’t grow proportionately with the growth in AUM. In simple words, the same resources can manage higher AUM.
Asset managers have tailwinds behind them—falling interest rates and attractively valued markets. Add to that, the low penetration of the mutual fund industry and you can imagine the potential growth trajectory of asset managers. India’s AUM to GDP ratio is merely 12% vis-à-vis the global average of 55%.
Large fund houses enjoy strong parentage, they have the financial muscle to upgrade their technological capabilities, run investment education campaigns, create awareness which eventually helps them garner more AUM.
The Indian mutual fund industry is dominated by 6-7 players, which collectively manage 71% of total AUM of the industry. As of now, only HDFC AMC and Nippon India AMC are the only two listed asset managers. However, investors take indirect exposure to AMCs by investing in their listed parent companies. For example, an investor of ICICI Bank also gets an indirect exposure to ICICI Prudential AMC since the latter is a subsidiary of the former. So is the case with some NBFCs.
Will more AMCs go public in future?
Will AMCs floated by Indian banks such as SBI AMC, Kotak Mahindra AMC, Axis AMC and ICICI Prudential AMC go public? Maybe in future, if the respective banks decide to unlock value, just like some of them did by listing their insurance businesses.
UTI AMC recently received SEBI’s go ahead to launch the Initial Public Offer (IPO). Three Public Sector Banks—SBI, Bank of Baroda (BoB), and Punjab National Bank (PNB) along with LIC hold 18.5% stake in the UTI AMC. T-Rowe Price holds the remaining 26% stake. According to media reports, PNB and T-Rowe will offload 38 lakh shares each while other players would part with 1.05 crore shares each.
To measure the attractiveness of IPOs that may come up in future, HDFC AMC and Nippon India AMC can be used as benchmarks. At the market cap of Rs 52,000 crore, HDFC AMC trades at 15% of Average Assets Under Management (AAUM) in May 2020 whereas, Nippon Life India AMC, with a market cap of Rs 19,000 crore, trades at 11% of its AAUM.
Many AMCs have been advising investors to invest in equity mutual funds if they are ready to take a risk and have a time horizon of at least 3 years. Quite a few of them see the Indian market delivering attractive returns over the next 2-3 years. Interestingly, it’s found that higher equity AUM helps improve PAT margins besides cost controls.
Now you might wonder, if the AMC business isn’t capital intensive why asset managers may dilute their stake by listing the business? After all, the profit gets added directly to the balance sheet of the parent company.
The reason is rather straightforward. After more than 2 ½ decades of presence, many bank-led AMCs have grown substantially. The business of banking is extremely capital intensive, especially considering the tough credit environment. Plus, there could be many merger and acquisition opportunities coming their way. For instance, ICICI Bank recently announced a plan to raise upto USD 3 billion. In the recent past it raised Rs 3,090 crore by divesting stake from both life and general insurance business.
Thus, bank-led AMCs might get listed at some point.
In the past, some marquee AMCs such as Fidelity and JP Morgan have exited India businesses which suggests, operating in Indian markets independently isn’t easy even for the globally renowned AMCs. Similarly, selling stake without listing a business may not be desirable for many players. Against that, listing a business helps discover the value and paves the way for future dilutions at higher multiples, as and when the business grows.
As fixed deposits offer paltry interest these days, investors are likely to turn to mutual funds. As disposable incomes grow and savings rate improves in future, Indian mutual fund industry is likely to grow rapidly. This leaves big AMCs in a sweet spot which have already achieved optimum scale of operations and profitability. Stickiness of SIP book during the coronavirus-inflicted market meltdown suggests that the Indian investor is maturing.
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We do not have any financial interest of any nature in the company. We do not individually or collectively hold 1% or more of the securities of the company. We do not have any other material conflicts of interest in the company. We do not act as a market maker in securities of the company. We do not have any directorships or other material relationships with the company. We do not have any personal interests in the securities of the company. We do not have any past significant relationships with the company such as Investment Banking or other advisory assignments or intermediary relationships. We are not responsible for the risk associated with the investment/disinvestment decision made on the basis of this blog article.