HDFC Asset Management Co. Ltd’s (HDFC AMC’s) initial public offering set the Street on fire, with listing gains as high as 65%. The mutual fund company is now valued at 12.54% of its average assets under management (AUM) in the June quarter, which puts its valuation at almost double the levels of Reliance Nippon Life Asset Management Ltd. Including Reliance’s pension AUM, its valuation falls to about 4%, which means HDFC AMC’s valuations are three times those levels.

While it is understandable that investors would want to value a company from the HDFC (Housing Development Finance Corp. Ltd) stable at higher multiples, they have clearly taken things too far with the mutual fund company. A look at the table alongside shows that while HDFC’s financial ratios are better compared to Reliance’s, the degree of outperformance isn’t that high to warrant such a large premium.

What then explains the mad rush for HDFC AMC’s shares?

It’s one simple reason: a terrible shortage of quality stocks in the Indian markets. Such is the dearth of listed companies that investors can trust that they pile on when a company with a pedigree lists on exchanges. The problem has been compounded lately, with a number of mid-cap stocks correcting sharply. Besides, with auditors resigning from a number of companies, investors are being doubly cautious.

But with companies that have a decent track record on governance, investors are throwing all caution to the wind when it comes to valuations. The rush for quality stocks is also evident in the high valuations of consumer goods companies and private sector banks, for instance.

CNBC-TV18 interviewed one of the bankers to the HDFC AMC IPO to understand the huge demand for the company’s shares. He said it doesn’t make much sense to look at price-to-AUM ratios, but rather at price-to-earnings (P-E) ratios, since a mutual fund can potentially make higher profits than a competitor with the same amount of assets.

But those looking for some semblance of sanity in the P-E ratio will be disappointed. HDFC AMC is now valued at 53 times earnings for the year till March 2018. Assuming earnings grow at the same pace as the previous year, the stock is valued at 41 times forward earnings. Note that fiscal year 2018 was a sort of a sweet spot for mutual fund companies, with equity AUM rising sharply. Even so, earnings growth stood at 31.1%. In the preceding year, earnings had grown just 15%.

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A valuation multiple of well over 40 times, therefore, means that investors are setting a high asking rate as far as future growth expectations go. If anything, things are expected to slow down after the high pace of growth in the past few years. Since large-cap equity funds have kept the faith, investors haven’t yet pulled out large amounts of funds. However, if the correction in the markets extends to the large-cap segment, the growth in AUM can soon come to a standstill.

Besides, the experience with developed markets shows that investors transition to index funds and exchange-traded funds, where fees are much lower. Already, some Indian fund houses have lowered fees for large-cap funds, because of the low alpha the segment generates.

To ignore all of this, and just focus on pedigree is clearly a myopic view.

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