Mint Money looks at how a change in financial regulations is impacting mutual fund distributors. In the second instalment of a 3-part series, we tell you stories of distributors who left their mom-and-pop shop days far behind to institutionalise their businesses
Nikhil Naik’s office in Goregaon (East), a Mumbai suburb on the Western railway line, is a throwback to the old times. The building, Jyotsna Prakash, which is right next to Goregaon railway station, is an almost 60-year-old. Naik’s office, a modest 130-sq.-ft space, is sandwiched between a kirana store and a chemist. It looks like just another shop and can be easily missed in the hustle and bustle. Inside is a decrepit reception and a room with a few tables, chairs, computers and some staff. The office is listed as his firm Naik Wealth’s head office on his website. But this is not where Naik sits anymore.
A few blocks away, as we are escorted up seven floors in a high-speed elevator at the glitzy D Definity Building where Naik now sits, we could not miss the generation gap. Seated in the posh 1,300-sq.-ft office is an army of about 20 people, busy tracking and analysing investor portfolios and markets. Television screens show the latest in the world of business and finance. Naik’s own cabin has a glass façade. A business to distribute mutual fund (MF) schemes and few other financial products that his father started in 1989 is now a distribution powerhouse managing close to 600 crore worth of assets.
Brick by brick
Naik is part of a new breed of distributors that have institutionalised their businesses and are far beyond the mom-and-pop shop days. Institutionalising the business does not mean the distributor goes after institutions to manage their money. That may well be, but that is another story. An institution as an investor is a large firm or a company. But to institutionalise one’s own business means to put in place systems and processes that have the capacity to manage a large number of investors, but without compromising on the quality of advice and fiduciary responsibility. Many things are automated, which removes the need for human intervention. Standardisation of advice (irrespective of who in the firm you speak to) based on a research-backed process that is continuously put through a stress test, and ensuring, among other things, that your money is properly tracked, are some ways in which a section of distributors have managed to grow their business over the years. It also means that the firm does not just depend on its chief to walk the path.
“Institutionalising to us is to not only reduce the keyman risk, but also to build a strong support structure for client-facing relationship managers (RM), reduce subjectivity in the investment process and maintain continuity," says Pramod Kumar, co-founder and chief executive officer, Wealth Advisors (India) Pvt. Ltd, a Chennai-based boutique wealth management firm.
Kumar’s firm essentially has three teams; one focuses on research (staff of eight), one meets and interacts with clients (staff of 20) and a separate operations or back-office team (staff of 14) that does the client’s accounting and also sends reports. “An RM, who faces the client, needs support. She needs product and research support in such a way that she can interact with her clients smoothly, because an RM has to do many things," says Kumar.
When Bengaluru-based Srikanth Bhagavat thought of converting Hexagon Capital Advisors Pvt. Ltd from a leasing company to a financial advisory company in 1999, he was sure of running a multi-member outfit. “It has to be professionally run. The firm has to run beyond my lifetime and continue to serve its clients. That can only happen if I professionalise. Growth can only be had if we have more people, so I had to increase my team size," he says. From hiring one person in the early years to help him manage investor portfolios, to repeatedly hiring trainees to help develop his website and sophisticated online portfolio tracking tools if his clients wished to see their latest portfolios, Bhagavat focused on improving systems.
Today, Bhagavat, whose firm is a registered investment advisory with the Securities and Exchange Board of India (Sebi), has a separate advisory division that consists of three people, two people in the research division, three who take care of their back-office operations and one person who is in charge of the firm’s compliance.
Mumbai-based Vinod Jain, principal adviser, Jain Investment Planner Pvt. Ltd, had a slightly different approach when he started off in 2001. Jain was no stranger to the capital market. While studying for his chartered accountancy exams, he had worked at a few brokerage houses, auditing their books of accounts, apart from dabbling in the equity market since 1993 as a 19-year-old. And having worked in a financial distribution firm a few years before he started Jain Investment, he was familiar with systematic investment plans (SIPs) and the power of compounding. He was also conscious that starting afresh would make it difficult to get large investors with deep pockets. What was the way out then? “The only thing I could have done at that point was to convince the retail investor to start SIPs. That was my core focus, and remains so," says Jain.
By 2003, Jain had about 80 clients and he wanted to expand. So he drew up a plan. The same year, he recruited a fresh-out-of-college, Masters in Business Administration (MBA) graduate, and gave him the task of getting SIP inflows worth 10 lakh a month. Every month. Of course, not overnight, but over time.
His logic was that if one investor invested 10,000 every month and if the fresher got 100 clients, that would make a monthly inflow of 10 lakh. But how does one get 100 clients? “It takes time to build this kind of a structure but I was willing to invest the time needed," he says. Jain started hiring advisers slowly. Each adviser he hired was given the same mandate. “An SIP of 10 lakh every month grows to little over 50 crore in 15 years, assuming equity funds grow by 12% per annum," he says.
Jain said that the MBA graduate touched an inflow of 10 lakh in two years. Soon he hired one more person and again gave him the task of building an SIP book of 10 lakh. And then another. And so on.
The first graduate still works at Jain Investments and now boasts of getting 30 lakh a month through SIPs. In 2008, Jain had 16 advisers working in his firm. Today, Jain Investment has 43 advisers on its rolls, who collectively bring in 4.3 crore worth of inflows through SIPs from 8,000 accounts, every month.
What is Jain’s secret sauce? His unusual strategy when recruiting advisers. He says he prefers to take people with no prior experience in selling MFs. He says that this is because he does not want his advisers to come with a preconceived notion on how to sell MFs. His first adviser—the MBA graduate—was a fresher. A few people came from back office operations of a fund house, some came from travel and advertisement industries, one, he says, was a sports trainer. “We still haven’t hired a journalist," he says with a smile. Let’s talk about that some other time, shall we?
An early start and a knack for spotting opportunities in virgin segments also helped some of these distributors build their empires. We meet Ashish Shah, founder of Wealth First, an Ahmedabad-based distribution firm of financial products, in his sprawling 8,000-sq.-ft, two-floor office, off the busy S.G. Highway in Ahmedabad.
Dashing into his cabin, he quickly removes his footwear, bows to a Lord Krishna deity, which is kept at a neatly made altar, puts his footwear back on and settles on a couch. A fast-talker who seems to be bursting with ideas, Shah is a savvy MF distributor and one of Gujarat’s biggest, with just MF assets of over 700 crore. But he made his name by aggressively selling tax-free bonds and debt funds. “All my individual investors are HNIs (high net worth individuals) in the highest tax bracket (30.9%). For those people, not only wealth creation, but safety and liquidity are also important. Investors should not put everything in equity funds blindly. Asset allocation is important, and tax-free bonds give a good post-tax return," he says.
Shah firmly believes that when it comes to fixed income investing, risk-taking should be at a bare minimum. Low commissions from tax-free bonds neither deterred him from recommending these big time nor did they push him to recommend credit income opportunities funds, which were then paying high commissions.
What is so special about tax-free bonds? They come with a tenure of 10-15 years and get listed on the stock exchanges if you wish to exit prematurely. Why then would Shah recommend a product that locks your money away for so long?
Fixed income market observers say that tax-free bonds almost always trade at a premium. In simple words, the market price is higher than the face value at which you buy them during the initial public offer. Why?
Take a look at the four tax-free bond issues in March 2016 by National Bank for Agriculture and Rural Development, Housing and Urban Development Corp. Ltd, National Highways Authority of India and Indian Railway Finance Corp. Ltd. The face values of all these bonds was 1,000. Till date, the lowest price level that these bonds have reached on BSE Ltd has been 1,010-1,030 (between March and mid-May) and the highest levels has been 1,068-1,142, during the same period.
“In short, tax-free bonds trade at a premium. So retail investors who got in at the start can sell them at a profit and get out if they need the money prematurely," says Ajay Manglunia, executive vice-president–fixed income markets, Edelweiss Securities Ltd. This means, there is liquidity.
But why does it list and trade at a premium? That is because a significant chunk of the bond subscription is allotted to retail investors (40-60% typically). Only 10-20% is reserved for HNIs; a segment for whom tax-free bonds make immense sense since they fall in the highest tax bracket. “There is always demand for tax-free bonds, so a long lock-in does not scare those who know these products well," adds Manglunia.
Elsewhere, in Pune in 2001, Bharat Phatak, founder and director of distribution firm Wealth Managers (India) Pvt. Ltd, sensed an opportunity in debt funds when he and his business partner carved out the MF assets of his erstwhile broking firm, into a separate entity. Being a chartered accountant (CA) who used to work with his father (this was before Phatak started his broking firm at the age of 33), who himself was a well-known CA in Pune in those days, Phatak gained an entry into various companies’ treasuries. He smelled opportunity here and aggressively got his company clients to invest in debt funds. Not only were dividends tax-free in the hands of investors, dividend distribution tax was much lower between 2000 and 2005, as compared to present levels. On the other hand, the short-term corporate tax rate was 35%.
“That is a huge difference in tax rates. Therefore, it made immense sense for companies to invest in debt funds in those days," says Phatak. It was not just debt funds that were new to Indian investors in those days. The concept of MFs itself was new to many investors and distributors alike. But distributors like Phatak warmed up to funds quickly because of the fund houses’ “adherence to long-term investment principles, portfolio construction and risk mitigation approach, seriousness about compliance and disciplined and structured methods of client relations", says Phatak.
The Pune-based distributor remembers Vijay C. Advani, who headed Franklin Templeton Investments (India) Pvt. Ltd till 2000, as being a rare chief executive officer who would meet individual investors. “He would always come for these meetings at least 10 minutes in advance, and begin the meeting with, ‘Sorry, I am early’." Phatak adds: “One of my clients had raised a query once. When Advani visited Pune, he visited our office and spent a lot of time with my back-office employees to get to the bottom of the issue." Today, Advani works with Franklin Templeton’s US office and is now the co-president of Franklin Resources Inc. He is responsible for Franklin Resources’ global retail and institutional distribution strategies and initiatives, client service, product development, and sales and marketing.
Adopting a cleaner path
While they kept one eye on returns and wealth creation, the other eye was on fund houses and financial instruments for signs of mischief. On 11 September 2001, Bhagavat was sitting in front of a television set with the head of treasuries of a private-sector bank watching with horror as terrorists struck the World Trade Centre in New York. The treasury head turned towards him—Bhagavat was the bank’s distributor—and demanded to withdraw all of the bank’s money that was lying in liquid MFs. He spoke to one of the fund houses where he had invested through Hexagon Wealth and demanded to withdraw the money, at the previous day’s net asset value (NAV). A catastrophe like 9/11, the treasury head thought, would send markets tumbling down, and so would the NAVs of MFs. So he demanded the previous day’s NAV, which would in all likelihood be higher. MF rules at the time stated that when an investor invests in liquid funds, she gets the units at previous day’s NAV, but when she withdraws, she gets the same day’s NAV. However, Bhagavat recalls, this MF obliged and bent the rules. “That raised red flags for me. It occurred to me that large investors got preferential treatment. That does not hold water for me. Today, my client would benefit, but tomorrow she could lose out because of another of this MF’s adverse policy. So, I eventually withdrew all of my investors’ money that was lying with the fund house," he says.
Most of these distributors also chose to stay away from credit and income opportunity funds. In the year leading up to June-July 2015, debt funds had increased their allocation to low-rated fixed income instruments, like those that came with a credit rating of below AAA. It all blew up on 27 August when the NAV of two of JP Morgan Asset Management (India) Pvt. Ltd’s schemes sank sharply on the back of a downgrade in one of its underlying stocks—Amtek Auto Ltd. A day after, the fund house had restricted redemptions in these schemes to 1% of the corpus in each of the two schemes. Earlier this year, Franklin Templeton Asset Management (India) Pvt. Ltd had sold its entire holding of Jindal Steel and Power Ltd’s debt securities at a loss after the company’s ratings was downgraded by Crisil Ltd. Despite having assets under management of 1,200 crore in tax-free bonds, 600 crore in taxable bonds and 400 crore in inter-corporate deposits and fixed deposits, Shah stubbornly avoided credit funds. Kumar, too, has stayed away from credit funds and feels vindicated. “I have spent 25 years in this business. One has to worry not only about ability of companies to repay but also intent to repay," says Kumar with a wry smile. “Also, we are not sure if a large section of investors fully comprehend credit risk," he adds.
The way ahead
With the advent of direct plans and Sebi’s registered investment adviser (RIA) guidelines, many of these distributors are now contemplating getting themselves registered as investment advisers, and then charge fees. While firms like Hexagon are already RIA and charge fees, others like Jain have preferred to get the portfolio management services licence. On its part, Sebi has become more vigilant and has been persuading distributors across the country to get registered. As most of these distributors put themselves out as advisers, the onus will be on them to stay on the right side of the regulations. The journey, for most of them, has already begun.