The last two decades have seen the phenomenal growth of the mutual fund industry in India. Within this industry, until a few years ago, there was only one listed player, Nippon AMC (Nippon India Life). The next one to get listed was HDFC AMC in 2018, followed by UTI AMC in 2020. The latest one listing on the market was ABSL AMC (Aditya Birla Sun Life) in 2021 and many more are expected to follow soon. 

As an investment theme, AMCs have seen growing interest from investors who want to  ride the rising wave of  financialisation of savings in India. However, this industry has faced several challenges in terms of regulations and changing customer preferences in  investing schemes. AMC stocks have performed poorly as a result in the last one year, and the performance of individual companies in Q1FY23 was lower YoY on key metrics. Part of this can be attributed to the fact that SEBI banned AMCs from issuing new NFOs (New Fund Offer) for three months from April to June this year.

Quick Takes

• Among listed AMCs, HDFC AMC continues to be the most profitable with an operating profit margin of 74.7% in Q1FY23
• HDFC AMC has the highest revenues among the listed players with 85% higher revenue than the nearest competitor at Rs 532.9 crore
• Q1FY23 was challenging for the AMC industry due to the ban by SEBI on issuing new NFOs.
• Another challenge was the high level of redemptions from equity funds in Q1FY23 following the downmove of the NIFTY50 to 15,000 levels in May.
• AMCs are also trying to keep up with changing customer preferences, where a clear shift is seen towards investing in passive funds vs active funds

AMCs disappoint with weak performance along with a ban on NFOs

The underperformance for listed AMC stocks in Q1FY23 was seen due to subdued industry AUM growth, which fell by 2% sequentially. HDFC AMC, ABSL AMC also lost market share due to some of the newer AMCs gaining on the more established players. The three month NFO ban by SEBI only added to the industry's woes. In Q1FY23 MTM losses in equity schemes were worth Rs 1.9 lakh crore and net outflow in debt schemes stood at Rs 1.1 lakh crore, according to data shared by the AMC industry body AMFI (Association of Mutual Funds of India).

As a sector that was expected to deliver stellar returns to investors, AMCs have largely underperformed with all the AMC stocks delivering more than 30% negative returns in the last one year. HDFC AMC stock lost 41%, which was the highest loser in the group, while UTI AMC lost 30.6%.

A major development at HDFC AMC was the resignation of its star fund manager and long time CIO Prashant Jain after serving more than 20 years in the company. The AMC was swift in appointing replacements internally for schemes managed by him. The future performance of HDFC AMC depends on how the new team takes the mandate forward.

While the ban on NFOs is one factor, it cannot be entirely blamed for the lower YoY revenue growth of all the listed AMCs. Another factor to consider is that the AMC business is highly competitive and the number of AMCs is rising each year. The newer AMCs are highly aggressive in their strategies to acquire customers and this comes at the expense of the market share of the more established players. 

Investors shift from equity to debt as the indices decline in Q1FY23

Investor psychology has a major role to play in the inflows of equity MFs. Many investors, after witnessing phenomenal growth in 2021, pulled out of equity mutual funds as the market corrected in 2022. While the equity funds continue to be positive, they have moderated in recent months.

Going by the latest AMFI data, equity mutual funds saw a net inflow of Rs 6,120 crore in August 2022. This is the lowest inflow that equity funds have seen in the last 10 months. Equity funds saw a total inflow of Rs 8,898 crore in July, Rs 15,495 crore in June, Rs 18,529 crore in May and Rs 15,890 crore in April, this year.

On the other hand, debt mutual funds witnessed an inflow of Rs 49,164 crore in August, much higher than Rs 4,930 crore seen in July, this year. However, hybrid schemes saw a net outflow of Rs 6,601 crore and Gold Exchange Traded Funds (ETFs) experienced a net outflow of Rs 38 crore.

Changing customer preferences is also one of the key reasons for the YoY decline in profitability of the AMCs. Over the past few years, there is a much higher demand for passive funds compared to active funds - an accelerating shift that has happened globally as well. The revenue source for any AMC is the Expense Ratio that it charges for managing the scheme. The expense ratio for passive funds is much lower than active funds  as the fund manager only needs to replicate an index, while active funds require a team of analysts and fund managers who research and make decisions.

Passive funds take centre stage in investor choices

Passive funds have made inroads into retail portfolios in 2022 as leading mutual fund houses have started to devise products for passive investing and are coming up with varied themes and new investing strategies in the passive space. As a result, the assets managed by the passive funds have grown substantially in 2022 so far.

The AUM of passive funds including ETFs, index funds, gold ETFs and Fund of Funds was at Rs 4.72 lakh crore as on December 31, 2021. The AUM was at Rs 5.71 lakh crore at the end of July 2022, a 22% increase in 6 months. In comparison, debt mutual fund AUM decreased by 12%, and equity funds grew by 6% in the same period.

The popularity of equity passive funds among investors has surpassed their actively-managed counterparts in recent months, driven by sustained inflows from index schemes of mutual funds.

One of the hypotheses that make AMCs an attractive investment option is that they have higher profit margins as compared to other industries. In Q1FY23, the operating profit margins have been steady with the exception of UTI AMC, which lost operating profit margins YoY by 6.1%. HDFC AMC has the highest operating profit margins at 74.7% in Q1FY23. 

These margins are still impressive for an industry that has many regulations including expense ratios. SEBI has capped the expense ratios of active funds based on the size of their AUM (assets under management). The higher the AUM, the lesser the expense ratio. That is why AMCs are keen to keep introducing NFOs. At the time of introduction, their AUMs would fall under the highest expense ratio category. The three month ban on NFOs impacted profitability for AMCs as they were unable to issue any NFOs in Q1FY23.

With the ban lifted in July, more than 14 fund houses have launched over 17 schemes in July 2022. It is expected that inflows will increase from this month. Analysts believe that investors who suffered losses from crypto and direct equities will shift to mutual funds. 

With many AMCs launching NFOs in both the passive and active segments after the ban was lifted, indices are moving up to their previous highs, a reversal from the lows seen in May 2022. The next quarter is likely to see the performance of AMCs improve. However, they have a long way to go before they can deliver outperformance as an industry.