This Market Correction is Spelling Trouble for India's Mutual Fund Firms

Asset Management Companies Q3: No sector is as closely tied to stock market movements as AMCs are. A sharp decline in equities can directly reduce the overall value of AUM (Assets Under Management) of asset management firms, eventually putting pressure on their bottom lines.

That's exactly what the markets are witnessing now.

In the last 6 months, broader markets have plummeted over 8.8%, driven by several factors, from valuation concerns to FII outflows. This correction has slowed down the quarterly average AUM growth for listed mutual fund firms to between 0% and 4%, a stark drop from the previous range of 9% to 14% growth seen in Q2FY25.

According to Centrum report, the mutual fund industry's quarterly average AUM grew by just 3.6% in Q3FY25 as compared to 12% recorded in the previous quarter.  In absolute terms, it added Rs 2.4 trillion in Q3FY25, a drop from Rs 7.2 trillion reported in the last quarter.

Besides this, lower mark-to-market (MTM) gains, wherein unrealised profits are incurred during market highs, have also taken a toll on the overall income of AMCs.

Even as the quarterly figures indicate a dim picture, there is a potential upside. Thanks to resilient SIP inflows, the quarterly equity AUM growth remains steady. However, analysts expect some pain ahead and are keeping moderate estimates for equity AUM growth in the coming quarters.

AMC Premium Faces Reality Check

For D-street players, short-term headwinds will persist. This will ultimately create an environment even more challenging for the industry as AMCs primarily earn profits by charging commissions on their average AUM across different asset classes be it debt, equity or ETFs. And, since equity assets generate higher fees, mutual fund firms with a greater equity allocation generally receive higher valuation multiples than those with a lower equity mix.

"As AMC earnings are driven by AUM size, asset composition and commission rates, the recent sharp decline in equity markets is expected to constrain average AUM growth, despite continued inflows. As a result, the likelihood of slower earnings growth for AMCs remains high," said Ajit Mishra SVP- research at Religare Broking.

Plus, despite steady SIP inflow, the overall slippage ratio in the instrument, which measures discontinued SIP accounts compared to new registrations, surged to 109% from 52% recorded in April last year, as per a report by JM Financials.

A simple equation seems to come out from this outlook, the higher the markets, the better the earnings for AMCs. However, the pain for the industry won't end here.

AMCs usually trade at a premium (as compared to broader markets) and considering the already sharp fall experienced by the shares of listed asset management firms, things might not add up well. This is largely because the bottom line of these companies can be adversely hit during market downturns as their earnings are directly linked to market performance. All 4 major listed AMCs (HDFC, Nippon, UTI and Aditya Birla Sun Life AMC) reported a drop in the 'other income' segment, this was largely on account of lower MTM gains.

While strong fundamentals might justify higher valuation as compared to overall markets, the same also acts as a reality check, making sure that investors don't overpay, especially during times of market downturn. "AMCs trade at a 40-50% premium to broader markets. While AMCs enjoy attractive traits such as strong cash conversion, a high degree of predictability and a growth runway, P&L (profit and loss) of AMCs are exposed to occasional market drawdowns with the expense flexibility to offset the impact and hence premium of broader markets offers a useful check on the valuations," Kotak Institutional Equities stated in a report.

Near-Term Headwinds Remain

Analysts believe that the near-term outlook for asset management firms will remain challenging, as the market trajectory is expected to stay volatile ahead owing to uncertainty in the geopolitical sphere and slower-than-expected earnings growth. For many D-street players, quarterly results remained in-line with the estimates, but the earnings downgrade ratio stood at 0.3x, the worst since Q1FY21, as per a report by Motilal Oswal.

On top of this, the higher base from the previous fiscal is making it more difficult for the sector to achieve robust expansion, Mishra said. HDFC AMC continues to come out on top in-terms of market share, which increased by 25 bps (basis points) YoY to 11.5%. Nippon AMC recorded the biggest gain, up by 60 bps YoY. However, the quarter wasn’t as favorable for UTI AMC and ABSL, as both lost market share.

Brokerages have revised their rating on AMCs as they bet on a strong long-term outlook, largely driven by a surge in disposable income and reduced SIP ticket size.

Kotak has maintained a Neutral stance on HDFC and Nippon AMC. "While superior fund performance for both will continue to drive stronger flow share, we assume 3-year equity AUM CAGR of 20% for HDFC/Nippon compared to 15/13% for ABSL/UTI," the brokerage firm said.

Centrum has maintained a positive outlook with a Buy rating on the industry, stating that recent stock corrections have created attractive entry opportunities for investors.