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AMCs and RTAs: Taking stock

Price performance of AMC stocks (12M) has broadly reflected underlying business momentum, with HDFC/Nippon (~50/80%) delivering better returns than ABSL/UTI (~5%/flat). RTAs were middling at CAMS (~20%) and Kfin (~35%), benefiting from AUM growth, along with signs of a scale-up in non-MF businesses. We like the earnings quality and growth potential of the sector, but current entry valuations require higher dependence on supportive markets/flows. Continue to prefer HDFC/Nippon (ADD) over ABSL/UTI (downgrade to REDUCE). Retain ADD on CAMS/Kfin.

AMCs: Prefer HDFC/Nippon (ADD) over ABSL/UTI (REDUCE)

We take into account recent market returns and net flow trends, and refresh estimates for FY2024-26E. Across AMCs, we see earnings upgrades by up to 9% in FY2025-26E. We find stronger earnings growth potential (17-18% EPS CAGR over FY2024-26E) for HDFC AMC and Nippon, given much stronger fund performance tailwinds. We do not anticipate quick turnaround in market share loss for ABSL and UTI, given current fund performance, leading to lower earnings growth (9-10% EPS CAGR). Barring any special situation, we believe the valuation gap to persist.

AMC stocks trade at 30-40% premium to broad markets

AMC stocks have re-rated sharply over the past 6-9 months, as a result of strong momentum in equity returns, flows and most importantly, abating of regulatory risks. Though well below their peak, valuations of AMC stocks are now at 30-40% premium to broader markets as compared with the nearly zero premium back in March 2023. The valuation premium for AMCs reflects key sector traits such as (1) strong cash flow generation, (2) high degree of predictability and low risks of negative surprises (such as credit costs/assumptions changes) and (3) well-aligned incentives across investors, distributors and asset managers. However, key structural pushback remains around (1) the lack of differentiation across fund managers in terms of product or client segment, (2) independent distribution network limits pricing power and (3) structural fee pressure due to passives/regulations.

Rise of SIPs and retail investing behavior

Growing SIP book has been one of the key characteristics of retail behavior in the current growth cycle. Share of SIP in flows and AUM has risen to ~35%. While the stickiness of the book is yet to be tested for sharp drawdowns and/or sustained low returns, it could provide better stability to overall flows. Although the quality and depth of data are limited to make a conclusive argument, we are likely seeing retail investors lengthen the investment horizon. Data on age-wise analysis of equity AUM for retail/HNI investors shows that the AUM share invested over 24 months has risen to 54%, as of September 2023, from ~45% two years ago and ~40% four years ago.

RTAs: Modest upsides for CAMS and KFIN

RTAs are a direct play on the MF industry, along with different revenue diversification approached for CAMS and Kfin. Compared with AMCs, RTAs offer stronger operating leverage, but come with elevated fee pressure, given revenue concentration from large clients. Over the medium term, profitable scale-up of non-RTA businesses along with lower client concentration can potentially lead to RTAs trading at a meaningful premium to AMCs. At this juncture, we believe current valuations offer only a modest upside. Retain ADD on CAMS and KFIN.

Retain ADD on HDFC AMC and Nippon AMC; downgrade ABSL AMC and UTI AMC to REDUCE

4 Valuations have limited headroom to expand; earnings could offer support. Four AMC stocks have a wide valuation divergence, which reflects recent earnings performance and the outlook on AUM growth and market share movements (Exhibit 1). Our positive view on HDFC AMC and Nippon reflects fund performance-led market share gains; this is reflected in better operating leverage and earnings growth over FY2024-26E.

4 Higher multiple for HDFC AMC (~31X FY2026E) assumes sustained growth outperformance over the next 3-5 years, led by tailwinds of (1) top-tier fund performance and SIP book, (2) distribution-related support from the parent bank and (3) likely lower fee drag (versus peers) at higher levels of AUM.

4 Nippon AMC’s turnaround in operating performance has played out as expected, supported by strong markets and its positioning in the small-cap category. The company has benefited from SIP growth, as seen from its sharp improvement in SIP flow market share. While this poses drawdown risks to the portfolio, we believe the fund house has a good performance track-record in other large categories (large/flexi/multicap) that can help diversify AUM and flows. Our FV implies a discount (~15%) to HDFC AMC, given potential to add growth through the captive bank channel.

4 UTI and ABSL AMC trade an attractive discount to HDFC/Nippon on top of our conservative view of medium-term earnings growth for both AMCs. While strong and sustained revival in fund performance can potentially lead to the reversal of market share losses, such trend reversal needs outlier fund performance, which then shows up in flows after a lag and a result harder to bet on. With a limited upside to our FV, we downgrade them to REDUCE (from ADD).

4 AMCs trade at a 30-40% premium to broader markets Following the bottom in February-March 2023, AMC stocks have rerated sharply over the past 6-9 months owing to lower regulatory risks and market returns along with strong retail flows. The premium to the broad market indices has also expanded from close to zero in March 2023 to almost 30-40% currently. However, their premium is still lower than the previous high of over 100% in 2019-20 (Exhibits 2-3).

4 The valuation premium reflects key sector traits such as (1) strong cash flow generation, (2) high degree of predictability and low risks of negative surprises (such as credit costs/assumptions changes), (3) granularity of earnings, (4) underlying product is highly accessible, transparent and inexpensive and (5) incentives are well-aligned across the ecosystem of investors, distributors and asset managers. However, key structural pushback remains around (1) the lack of differentiation across fund managers in terms of product or client segment, (2) independent distribution network limits pricing power, (3) structural fee pressure due to regulations and (4) threat of passive substitution.

4 What is the downside scenario? A hypothetical sensitivity to earnings from weak AUM growth is shown in Exhibit 6. Assuming two years of zero equity AUM growth (say zero flows and returns) could lead to ~15% earnings downgrade to our assumptions. The drag from no AUM growth is offset by the cushion available from low or zero yield compression, given static AUM sizes. This coupled with some pull-back on expenses will likely limit earnings downgrade in such a scenario.

Long-term profitability: Earnings growth similar to AUM growth

Over the past decade, AMCs have delivered 23% AUM CAGR, driving 14% revenue CAGR and 22% earnings growth (Exhibit 7). AMC’s performance has gone through volatilities, resulting from market movements, flows and regulations. We have segregated the financial performance into the period before the last round of the TER cut (effective FY2020) and period under the new TER rules. Earnings growth after the TER cut has been sluggish, but compensated in earnings through stronger operating leverage (Exhibit 8). We believe the sector has tailwinds to deliver 15-20% AUM growth over the medium term, which can potentially lead to earnings compounding in the similar range. However, this view is contingent on the relatively benign view of passive risks over the next 3-5 years.

AMC fund performance

The following exhibits provide an overview of active fund performance for large mutual fund houses. The sample covers a large sample of the equity-oriented portfolio for each AMC. HDFC AMC is going through a strong run of fund performance, followed by Nippon AMC. This augurs well for market share gains.

Rise of SIPs and retail investing behavior

Growing SIP book has been one of the defining characteristics of retail behavior in the current growth cycle. Share of the SIP book in flows and AUM has risen to ~35% (Exhibit 19-22). While the stickiness of the book is yet to be tested for sharp drawdowns and/or sustained low returns, it is likely providing better stability to overall flows for the industry. New fintech players have also pushed SIP growth and now likely contribute 40% of volume and 15-20% of value of industry SIP creation.

Retail equity investing in India is a more recent and growing phenomenon. Around ~55% of current retail equity AUM in mutual funds has been invested in just the past two years. Mature markets such as the US, with a long history of mutual fund investing, have a longer vintage portfolio of assets (see Exhibit 23-24). We have also seen progressively earlier start to investing in the US over the past decades. We could see this play out in India as well.

Though the quality and depth of data are limited to make a conclusive argument, we are likely seeing retail investors lengthen the investment horizon. Data on age-wise analysis of equity AUM for retail/HNI investors shows the share of AUM invested for over 24 months has risen to 54%, as of September 2023, from ~45% two years ago and ~40% four years ago (Exhibit 25).

India’s recent growth in MF AUM is at a similar juncture as the US was in the early 1980s, when the MF industry took off with strong growth during 1980-2000, as MFs became the default choice to build wealth and save for retirement. India could probably see this play out through the SIP route (Exhibits 26-30).

RTAs: Valuations offer limited upside; returns linked to AUM growth

MF RTA contributes nearly ~90% and ~65% of revenues for CAMS and KFin, respectively. As a result, growth prospects of RTAs are tightly linked to fee growth of the mutual fund industry. We are building 15-16% average AUM growth in FY2025-26E, which drives 10-12% revenue growth in the RTA business. We believe this business has operating leverage that protects margins and potentially investments in the non-MF businesses. We build stronger growth assumptions in the non-MF business for both (~25-30%), but growth trends are harder to predict, given the small scale (CAMS) and/or lumpy contracts (Kfin).

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