The Indian mutual fund industry opened up to the private sector in 1993. During its 24-year journey, the industry has seen numerous rounds of entries and exits by different entities. It has also seen significant growth and consolidation over this period. Yet, it remained privately owned during this entire phase. No mutual fund chose to come out with an initial public offering (IPO) during this period. The two bull markets of 2000 and 2008 did not really create any urgency in the industry to list. But this time it seems different. Every large mutual fund company in the industry is considering monetizing the asset management business. Soon, we could well see half a dozen listed names among mutual funds. Everybody is looking at the listing opportunity very differently this time.
What is it that has changed the minds of mutual funds sponsors and why it is so important for them to list? Firstly, it is important to understand the architecture of the industry and its operating model. The architecture and model of the industry have been reasonably static for long till about a few years ago. Relative to history, we see a growing urgency to change these, and regulation is the key driver. It is in the context of the regulatory urgency that this sudden rush to list becomes interesting.
Till about 2008, the industry was in its growth phase and all stakeholders were keener to keep their cost and pricing structures conducive to growth and—in many quarters—gathering assets. Disruption was hardly on the agenda.
The first hint of regulators taking a more active and dynamic policy stance that could potentially disrupt the industry was in 2009. Effective 1 August 2009, Sebi abolished the levying of entry loads on mutual fund schemes. This was a major disruption and the industry waited for 3 years for its reintroduction before giving up. The disruption truly began in 2009. The incentive structure for selling mutual funds changed forever and there have been a series of initiatives that continue to carry forward the disruption. The story had actually just begun. In January 2013, Sebi introduced the direct plan option where investors could invest in a mutual fund scheme without any intermediary. This revolutionised investor interest and once again reduced the bandwidth of the fee-earning ability of fund houses. Initially, there was a furore. But things settled down quickly.
The phase between 2014 and 2017 has seen explosive growth. The growth has been distinctively lumpy. Systematic investment plans (SIPs) have become the engine of the industry, giving it a veil of predictability of asset gathering.
One of the biggest reasons behind AMC IPOs is that the mutual fund industry knows that progressive, incremental regulation will restrict income growth of the industry and a series of potential measures will alter economics of the industry over the next decade. A quick IPO will create profits for the sponsor companies that can compensate future revenue losses from changes, if any, in total expense ratios (TER). The hurry seems to beat that disruption.
Secondly, the sponsors see an urgent need to prop up earnings of their own parent firms and part-selling these assets will be crucial for their near-term profits. The monetization of AMCs will also bolster their parent’s sum-of-the-parts (SOTP) valuations. The best time to monetize a mutual fund is when both market valuations and AUMs are around the all-time highs. Clearly, they could not have got a better moment. The IPOs seem to be perfectly timed. The valuation of AMCs seems to be at their elastic best. It is believed that IPOs could value AMCs at 5-7% of AUM. In comparison, past M&A deals were significantly lower. The assumed predictability of asset gathering and the lack of quality growth businesses have created a huge market expectation for the mutual fund issuances.
Draft Red Herring Prospectuses (DRHPs) are being filed with Sebi and there is a great rush to list.
Listing comes with enormous responsibility. A fiduciary industry seeking public capital or valuation will raise immense scrutiny. Shareholders and unit holders will often have varying objectives and expectations. The industry has grown tremendously over its recent years. For an asset management company (AMC), the primary contributor for valuation is the growth in the assets under management (AUM). The AMC needs to show growth and this growth also needs to have a wider, predominant equity scheme orientation. AUMs in equity schemes are valued significantly higher than those of debt schemes. The inherent reason is the better fee structures applicable on equity schemes. These fees structures are regulated by the Securities and Exchange Board of India (Sebi) and have a history of being reasonably static until these last few years and the debate is about to get shriller as time goes by.
One thing is certain. The mutual funds industry knows it better than anyone else that good times don’t last forever.
Shyam Sekhar is founder of ithought, an investment advisory firm