The long game is a strategy with big payoffs in a developing economy like India, where many sectors are under-penetrated. This is true, for example, in the capital markets space. Until recently, there were few companies here that worked as a proxy for the increasing financialisation of India’s savings. But in the last five years or so, investors have had more options, including mutual fund asset management companies, stock brokerages, and registrar and transfer agents.

One such company looking to take advantage of this need for diversification in the bull market is Aditya Birla Sun Life AMC (ABSL). While it would be easy for a company to price its initial public offering of shares at a stiff premium in the current market conditions, ABSL has shied away from such temptations for its Rs 2,700 crore IPO.

The company has already raised Rs 789 crore through its anchor book on Tuesday. The IPO opens on September 29 and closes on October 1. The price band of the issue is Rs 695-712. At the upper end of the price band, ABSL is valued at 33 times its annualised Q1FY22 earnings, while its peers like HDFC AMC, Nippon Life India Asset Management, and UTI AMC are trading at a TTM PE of 48, 40, and 34, respectively.

As a percentage of average asset under management (AAUM) as of June 2021, ABSL’s issue is priced at 7.2% of AAUM. HDFC AMC trades at 15.4% of its AAUM, Nippon Life India Asset Management at 10.8% and UTI AMC at 7.1%.

The issue is entirely an offer for sale by the two promoter entities Aditya Birla Capital and Sun Life. Aditya Birla Capital owns 51% stake in ABSL, with the rest held by Sun Life. Aditya Birla Capital will sell 28.5 lakh shares while Sun Life will sell 3.6 crore shares through the IPO. After the IPO, Aditya Birla Capital will hold a 50% stake in ABSL, and Sun Life will hold 36.5%.

The fact that ABSL is the largest non-bank promoted mutual fund AMC in Aditya Birla Capital makes it an intriguing prospect for the company. The company also runs a tight ship and has decent return ratios. Does the aggressive pricing of the IPO make it worth buying for investors?

Secular rise in AUM to continue, with more investors moving to equity

With the equity markets seeing huge inflows, it’s not a surprise that equity assets under management or AUM have seen an uptick over the past couple of years. Over the past 10 years, the average AUM of the mutual fund industry rose to Rs 33.2 lakh crore from around Rs 7 lakh crore, which is a compounded annual growth of 16.4%, according to CRISIL Research.

Over the past 18 months, the industry average AUM has grown nearly 40% as the industry recovered post the Covid-19 pandemic. This has come with increasing penetration into cities beyond the top 30 large cities (B-30). The number of individual mutual fund folios (retail and high net worth individuals) in the industry rose by nearly 13 million over to 102 million from March 2020 to June 2021.

CRISIL Research expects the industry’s quarterly average AUM (QAAUM) to rise to Rs 57.6 lakh crore by March 2026 from Rs 33.2 lakh crore at the end of June 2021. Equity QAAUM for the industry, which was Rs 14.6 lakh crore at the end of June 2021, is expected to rise to nearly Rs 26 lakh crore by March 2026.

ABSL AMC had a market share of 8.3% at the end of June 2021, behind SBI AMC, HDFC AMC, and ICICI Prudential AMC. The three companies ahead of ABSL are all backed by banks, which makes ABSL’s fourth position even more commendable.

The increasing preference of individual investors towards equity mutual funds is reflected in ABSL’s equity QAAUM slowly rising over the past many years.

ABSL is planning to increase its penetration in B-30 cities as more and more investors look to equity as an asset class. The recent change in tax law that taxes proceeds of unit-linked insurance policies sold by life insurance companies will also help increase the company’s and the industry’s equity AUM over the next few years. This is because the taxation of ULIP proceeds has been brought at par with equity-oriented mutual fund schemes.

Decent return ratios despite fall in revenues

A couple of years ago, SEBI changed the basis for the calculation of expense ratios (essentially fees AMCs charge investors). This led to a fall in fee income across the board in the industry. ABSL managed to weather this storm, control its costs, and post decent profits over the past three years.

The company’s hub and spoke model of running its physical operations helps it in controlling its operational costs, which in turn helped its cost-to-income ratio drop to 46.7% at the end of FY21 compared to 49.32% at the end of FY20. This is higher than the average of 40.5% of the top 10 mutual funds in FY21 (vs 47.97% in FY20).

But the general rise in the mutual fund industry AUM has helped the company’s fee and commission income rise in Q1FY222 compared to Q1FY21. This also helped it post higher profits YoY in Q1FY22.

What bodes well for ABSL is its high return on equity compared to its listed industry peers. And this is what might make it an interesting proposition for investors looking at playing the capital markets theme. 

With the increasing use of digital channels to transact (87.75% of total transactions in FY21 vs 70.92% in FY19), there will be a downward push in costs. But there are many new entrants waiting in the wings to enter an already crowded Indian mutual fund industry that has 41 AMCs. There is also an increasing preference for passive investing through index funds and ETFs by investors in the equity mutual fund space. This brings about its own challenges to revenues as passive funds are usually priced at a fraction of actively managed funds.

As competition increases, there will be pressure on incumbents like ABSL to also reduce the total expense ratio (or TER) they charge to investors. In this context, investors are bound to be intrigued by ABSL’s IPO, which is priced at par.