Mumbai/Hong Kong: India’s fund management industry, in boom mode for the better part of the decade, is facing a major slump in profitability as investment flows shrink, competition mounts and operating costs stay stubbornly high.
The downturn, triggered by a near one-third plunge in Indian stocks this year, will be particularly painful for smaller firms which have already been suffering losses and global fund houses which recently paid top dollar to enter what was viewed as a high growth market.
“There probably are firms thinking this was a bloody big mistake. We thought this was going to make us money. We had no idea this was going to be a drain on our resources,” said Shiv Taneja, managing director with Cerulli Associates in Singapore.
Some foreign fund houses have long-time roots in India. Prudential Plc.’s ICICI Prudential Asset Management venture with ICICI Bank Ltd is second in size only to Reliance Capital Ltd’s fund arm. Franklin Resources Inc., which set up its India office in 1996, is the No. 6 fund house.
More recent arrivals include Pioneer Global, the fund arm of Italy’s UniCredit, insurer American International Group Inc., US investment bank JPMorgan Chase and Co. and South Korea’s Mirae Asset Financial Group.
Mesmerized by a five-year bull run in which stocks rose 500%, Indian investors poured into equity funds. The industry grew more than four-fold over the period to manage Rs5.5 trillion by the end of 2007. Assets have shrunk about 5% since then. But fund executives said the underlying situation is much worse than that suggests because of the drop in assets invested in stocks.
Equity funds, which typically carry fees of about 1%, are the industry’s most profitable products. Many bond and cash funds, by comparison, charge 5-25 basis points. Hundred basis points make one percentage point.
Industry data showed equity assets have shrunk by nearly a third on back of the stock market decline. India’s benchmark stock index, the Sensex, is down more than 32% at Thursday’s close of 14,355.75 points compared with the record 21,206.77 points it hit in January.
More ominously for future growth, equity fund inflows fell to their lowest in June since August 2006 and new stock funds have collected just Rs1,830 crore so far in fiscal 2009, compared with Rs6,335 crore in the year-earlier period.
Rents and salaries up
Naveen Tahilyani, a partner with consultancy firm McKinsey and Co., estimated the profitability of large and medium-sized players in India was about 23 basis points of assets under management last year. Factoring in the shift to lower margin products, he said profitability for the industry could drop to below 15 basis points this year. This means a firm managing $100 million (Rs425 crore) in assets would earn a profit of just $150,000 on that money.
By comparison, the industry’s operating profit as a percentage of average assets was 12 basis points in the UK and 18 basis points in the US, McKinsey said in a report early this year.
“It is going to be tough, for sure...if people have spent a lot of money in building their business and they were looking for a payback this year, they are not going to get it,” said Sanjay Prakash, who recently stepped down as chief executive of HSBC Holdings Plc.’s India fund unit to take another role with the bank.
India’s fund industry has also found operating margins squeezed by spiralling real estate and staff costs.
“You’re essentially talking about an emerging market with first-world prices, in some cases even more than first-world prices,” said Cerulli’s Taneja.
Nearly all of India’s 34 fund houses operate out of Mumbai, which is one of the five most expensive office markets in the world, according to consultancy firm CB Richard Ellis Group Inc.
Salary costs have remained high as firms compete to hire and retain the fast growing industry’s limited talent pool. Industry sources said pay cheques for some star managers have topped $1 million, moving towards levels seen in London and Tokyo.
The bear market has moderated the pace of pay hikes. “Earlier, anybody would have expected that if you are jumping from one (fund) to another, you have to double your salary. At least now there must be a modicum of sanity,” said Sanjay Santhanam, a director with Canara Robeco Asset Management.
Salaries look unlikely to fall because the number of fund houses is still on the rise, with some 20 firms said to be looking to break into the industry.
Massive potential lure
A market rebound could turn the situation around. But a resumption in the bull run seems far from certain given the hawkish stance of the Reserve Bank of India, which recently hiked interest rates to curb high inflation, and ongoing worries about the global economic slowdown and credit crunch.
Still, with one in every six human beings on earth, a 32%-plus savings rate and economic growth of more than 8%, India’s long-term prospects present a powerful lure. Many global fund houses view the near-certainty of short-term losses as the price of admission to tap that massive potential.
Cerulli forecast in May that assets of Indian mutual funds will more than double to $302 billion by 2012, powered by strong economic growth and better distribution.
But Cerulli’s Taneja said fund houses must be prepared for the prospect that profits could be some time off. “If you don’t have the stomach for the long fight, then markets like India are not the ones you should be looking at.”