HDFC Asset Management Co. Ltd, one of the largest fund houses in India, posted a steady 28% rise in earnings before interest, tax, depreciation and amortization (Ebitda) for the quarter ended March 2019. This came on the back of an 18% year-on-year increase in assets under management (AUM) to nearly 3.44 trillion.

Some of the rise in net profits also reflects the changing nature of the business. Last year, the Securities and Exchange Board of India (Sebi) banned asset management companies (AMCs) from paying upfront commissions and other such fees through their profit and loss accounts. This substantially lowered operating expenses as the payment of commissions fell substantially. Fees and other commissions declined sharply to 29.85 crore in the March quarter from 100 crore a year earlier. Ebitda margins climbed to 73.3% in the last quarter from 59.61% a year earlier.

There are more regulatory changes coming up that affect financials and, unfortunately for investors, the impact will be negative this time. Sebi has notified a cut in the total expense ratio (TER), which fund houses charge to manage assets. The new structure has introduced slabs, which progressively reduce total expenses. As a result, revenues of all large fund houses will be hit.

HDFC AMC expects to pass on some of this impact to its distributors in the form of lower trail fees.

Analysts expect the net impact to be low. A report from JM Financial Institutional Securities Ltd points out that HDFC AMC’s blended equity fund TER is about 24 basis points. Of this, about 21 basis points are likely to be passed on. Hence, the net impact on HDFC AMC’s revenue is expected to be about three basis points.

The scenario, however, is evolving and it is to be seen how much the firm can actually pass on. This is especially because Sebi has banned upfront commissions and a substantially lower TER reduces distributor margins. This may not be taken too well by distributors. Last year, though, some TER changes were passed on to distributors.

“It remains to be seen whether AMCs (especially the large ones with higher bargaining power, such as HDFC AMC) are able to pass on the bulk of the TER cut to distributors as well," said JM Financial in a note to clients.

The HDFC AMC stock is expensive. It has slipped 11.1% since August 2018 but still quotes at a lofty earnings multiple of 36.7 times FY19 earnings. The company has a valuation of 10.5% of its average AUM in the March quarter, almost exactly the valuation it had last August, before Sebi announced its drastic TER changes. Investors’ hopes are undoubtedly running high with HDFC AMC.

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