India’s mutual fund penetration (assets under management (AUM) as percentage of GDP) is at 15 per cent - lower than the global average of 75 per cent and far behind developed as well as other emerging economies. A long list of Asset Management Companies (AMCs) operate currently, but the pie is expanding, with many new players jumping in to tap the huge potential.

With SEBI’s fund categorisation norms, product offerings fall into straight-jacketed buckets, though existing and new fund houses are coming up with innovations in passive and thematic categories. What distinguishes the latest entrants more is their lower expense ratios as well as their ability to widen reach through digital presence.

However, a performance track record for funds across many years and market cycles is key to earning investors' confidence and this tilts the odds in favour of established fund houses such as Aditya Birla Sun Life (ABSL) AMC, whose IPO is open from September 29-October 1. According to the offer document, of the top 20 open-ended schemes constituting 87 per cent of the quarterly average AUM as of June 2021, 13 schemes have outperformed peers over a 10-year period.

While the AMC has seen some market share loss in the last few years, ABSL is still the fourth largest fund house in terms of average AUMs (about Rs 3 lakh crore as of August 2021), with a market share of 8.32 per cent - a position which it has achieved without having the distribution muscle of bank-backed AMCs such as SBI, HDFC and ICICI Prudential who constitute the top 3.

The issue of about Rs 2,700 crore, entirely an offer-for-sale by promoters, values the company at 6.7 per cent of its average AUM as on August 31 and at about 35 times the company’s trailing 12-month earnings. These parameters are at a good discount to HDFC (15 per cent and 49 times) and Nippon (10 per cent and 40 times) AMCs and on par with UTI AMC.

The current valuation does not give room for sharp gains in the near to medium-term. But given that it is a growing industry, ABSL AMC, with its pedigree, track record and operational efficiencies, promises good prospects. Investors with a long-term perspective can subscribe to the issue.

Improving equity mix

ABSL AMC scores on steady growth in equity and individual AUMs. Individual investors prefer equity-oriented schemes and tend to stay invested for longer. As of June, 87.6 per cent of the equity AUMs for the industry came from individuals. Besides, within equity AUMs, the share of individual AUM in the “ > ( greater than) 24-month bucket” witnessed a sharp increase of about 10 percentage points from March 2016 to June 2021. These attributes of individual investors bodes well for AMCs as a higher share of individual investors provide committed AUMs and boosts profitability too, since margins on equity schemes are higher than debt and passive ones.

For ABSL AMC, equity AUMs constitute 38.1 per cent of its total AUMs today. While it is lower than other listed peers such as HDFC and Nippon AMCs, it is an improvement over its 23.6 per cent share five years ago. The share of individual AUMs for the company has grown from 39.95 per cent as of March 2016 to 47 per cent by June 2021. The market share of individual AUMs, at 7.27 per cent for the company, is higher than both Nippon and UTI AMC. SIPs as a percentage of equity AUMs stand at 42 per cent as of FY21 compared to 32 per cent in FY19 -– indicating the expanded retail reach.

Cost efficiencies

ABSL AMC also has an edge in digital presence and direct plan penetration. Deriving 15.76 per cent of its AUM from B-30 (beyond top 30) cities - an underpenetrated market with high growth potential - its reach is not the best-in-class. However, it is still better than HDFC, ICICI Prudential and DSP AMCs on this front. Simultaneously, its tilt towards direct plans and digital transactions indicates that it is expanding its base with lower costs. ABSL AMC’s share of direct plans has consistently improved in the last five years and stands at 50.05 per cent as of June 2021 - higher than HDFC and UTI AMC. This share is also 4 percentage points above the industry average. The digital share of overall transactions for the company stood at 85 per cent in FY2021. For the other three listed players it is anywhere between 49 per cent to > 80 per cent. Going forward, increasing fund sizes, higher competition and further regulations could cap free income for AMCs. Hence, operating leverage and cost efficiencies would be key.

The total cost to income ratio for ABSL AMC dropped to 46.7 per cent in FY21 from 49.3 per cent in FY20. HDFC AMC and ICICI Prudential, though, have the lowest total cost-to-income ratio of 20.57 per cent and 28.24 per cent, respectively. Employee costs as a percentage of average AUM, too have been coming down for ABSL AMC, and stood at 0.09 per cent in FY21. Whether employee compensation across the industry will go up as a result of compliance with SEBI’s skin-in-the-game rules (to make up for lower cash flows in employee hands) needs to be seen though.

In the last three fiscals revenues from operations dropped from Rs 1,405 crore in FY19 to Rs 1,233 crore in FY20 and further to Rs 1,191 crore in FY21. This was driven by the impact of a mandatory cap on total expenses (TER) as well as a drop in average AUMs due to the pandemic as well as market volatility initially. However, profits during this period have increased at a CAGR of 8.3 per cent to Rs 526.2 crore as of March 2021, thanks to lower expenses. The PAT margin for FY21 stood at 43 per cent, rising from 31.7 per cent in FY19. Its return on net worth as of FY21 stood at 30.8 per cent, higher than HDFC (27.7 per cent), Nippon (21.9 per cent) and UTI (15.2 per cent) AMCs.

Low capital requirement beyond the initial investment, sanguine growth prospects and good profitability make AMC businesses an attractive bet for investors, provided the valuation is not forbiddingly expensive. ABSL AMC IPO makes the cut.