After decades in the business, fund houses are moving forward with monetising their asset management businesses. Why now?
Reliance Nippon Asset Management hit the market last October with a Rs 1,500-crore IPO. HDFC Mutual Fund's IPO is coming out this week and indications are that a UTI AMC IPO will be next.
Clearly, the asset management business (AMC) is booming, and managements are moving to unlock value for existing investors. The growth trajectory of the domestic mutual fund industry has accelerated in the recent quarters at the back of structural reforms, reduction of black money, lackluster performance in real estate, and investors are being nudged into equities.
Domestic investors have pumped money into financial assets, leading to rapid AUM growth for fund houses. Despite this recent acceleration, the penetration of mutual funds among households is still dramatically lower than developed markets, at less than 5 percent of financial savings.
Indian mutual fund's share of financial savings is extremely low as well, at 3.5 percent of financial savings. The industry could grow at high growth rates of 20 percent over the next four years, in which case blue-chip names like HDFC should grow even faster.
Profitability growth is another matter, however, and we address that separately below.
The HDFC AMC IPO is all set to get a valuation of close to 8 percent of its AUM of Rs 3 lakh crore. This is at the extreme high end of the traditional band as AMCs have traditionally received valuations as low as 2-3 percent of their respective AUMs.
Reliance's valuation today is Rs 13,341 crore, or roughly around 5 percent of its AUM. IDFC's AMC is being negotiated at a valuation of around 5 percent of its AUM, at a premium to norms but a discount to HDFC, due to the latter's superior market positioning, branding, and execution.
Promoters are monetizing their AMC businesses at high valuations amidst strong sentiment; on the other hand, the growth opportunity is huge, as financialization is likely to continue and AMC remain well positioned to garner a large share of the profits.
For an investor what is ideal? Is it better to own shares of HDFC Asset Management or units of one of HDFC Mutual Fund's schemes?
HDFC AMC's revenues have grown at a compounded annual rate of 19.3 percent and profits at 14.6 percent between fiscal 2013 and fiscal 2017.
One must keep in mind, though, that AUM growth is cyclical in nature. During bull markets, growth is accelerated by returns on existing asset base and new capital infusions.
However, AUMs tend to reverse sharply during bear markets and corrections. A reversal in investor appetite for investing in mutual funds is a key risk of ownership.
As a result, the stock price of an asset management company will be somewhat volatile and will have a tendency like a cyclical during cyclical downturns. From this perspective, owning a diversified growth portfolio clearly makes better sense.
We would also note that there are headwinds in the industry. With the increasing adoption of the direct code, profitability is in a declining trend. Industry disruption via fintech also creates uncertainty.
Continued underperformance of funds relative to the benchmark could also lead to a slowdown in asset growth.
Clearly, valuations are the key concern. HDFC Asset Management Company is seeking a valuation more than twice that of its close rival Reliance Mutual Fund in its offering last year at close to 8 percent of its AUM. High entry valuations will remain a headwind for investors.
Taking the various factors into account, for an investor with a long-term horizon, HDFC will likely grow into its valuations.
Cyclicality and valuation concerns are balanced by the prowess of HDFC in garnering assets, as well as its better financial performance relative to peers.
However, an investment in the mutual fund is a wiser investment for an investor. If the mutual fund owns a leader like HDFC AMC, even better.
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