HDFC vs Nippon Vs UTI vs Aditya Birla Sun Life AMC: SEBI's proposed changes to TER norms can reduce profits of MF firms

The Asset Management Company (AMC) industry is staring at a slew of potential regulatory changes. To cite a few, SEBI’s new discussion paper proposes a drastic change to the total expense ratio (TER) regulations. SEBI has proposed bringing all taxes – such as GST and STT – and brokerage payments within the fold of TER guidelines.

"To balance stakeholder interests, markets regulator SEBI has proposed inclusion of several charges (GST on fund management charges, STT and brokerage), which were excluded earlier, in total expense ratio (TERs). These changes may hurt listed equity asset managers’ yields by 2-20 bps," said Nuvama's sector report on asset managers. The total expense ratio is the total fee that is associated with managing and operating mutual funds and is charged to investors annually.

Additionally, Securities and Exchange Board of India (SEBI) has proposed a lower non-equity TER on the debt component of hybrid schemes. This may result in listed asset managers' FY25 net operating profits going down by up to 27%.

"We believe the proposed changes to TER regulations, if not passed on to intermediaries, could dent listed asset managers’ FY25E APAT by as much as 27%. We are building in up to 50% transmission of this change in TERs to companies. Currently, we are not building additional costs on this account, which may be a further hit to earnings. Additionally, we think the changes in income tax laws in the union budget FY23–24 pertaining to MFs with less than 35% exposure to domestic equity would dampen inflows into debt scheme by 10–20%. This would affect the size of such schemes in the long run," as per Nuvama report.

Over time, SEBI has tightened regulations to safeguard investors from excessive costs and from distributor malpractices. Some of the key changes are scheme recategorisations, TER reductions, and the ban on upfront commissions. Even so, industry commissions on a blended basis have been rising due to a change in upfront commission to trail commission and highly competitive intensity.

According to the report, the operating landscape at large is conducive for long-term growth. First, yield decline is decelerating as legacy AUM now makes up a relatively modest 40–50%. Second, competitive intensity in NFOs is markedly lower—in the wake of moderating equity inflows.

HDFC AMC
HDFC AMC is a sought-after brand in India’s nascent and underpenetrated asset management industry. It boasts the largest market share in individual assets of 12.7% (Mar-23). The merger of HDFC with HDFC Bank is expected to further enhance HDFC AMC’s reach. An extremely low operating cost of just 14bps to AAAUM provides ample cushion to profitability. Even so, assuming a 50% pass-through to intermediaries of the hit from proposed TER regulations, HDFCAMC’s FY25E earnings would be impacted by 14%, as per the report.

Nippon Asset Management
Nippon Asset Management (NAM) boasts a strong retail franchise (share of 8.6%) in India’s asset management space. It is steadily capturing HNI share (up 70bps to 5.6% in FY23 vis-à-vis FY21) and shoring up SIP mix (up 60bps to 7% in FY23 versus FY20’s).  Meanwhile, NAM’s presence in passives is noteworthy (12% share)—third after SBI MF and UTI MF. Nippon Life, via its subsidiaries, can enhance NAM’s AUM base. Lastly, NAM’s focus on cost control keeps profit volatility in check—pre-EBITDA cost of 19.3bps in FY23 versus 28.5bps in FY20.

UTI AMC
With a 4% market share in active equity AUM, UTIAM ranks ninth in the industry. It is predominantly a mutual fund distributor (MFD)-driven granular distribution business (55% equity assets) with solid B-30 penetration (8.1% market share). "We see its investments in the international and retirement solutions businesses adding wind to its sails. Inheriting the ‘UTI’ moniker from its government entity days drives a strong brand recall for UTIAMC. Despite traditionally high/sticky costs, UTI AMC is least vulnerable to SEBI’s regulatory proposal—we estimate an APAT hit of just 3% versus 27% for HDFC AMC," said Nuvama.

Aditya Birla Sun Life AMC
ABSL AMC has a strong MFD-led retail distribution platform (54% equity AUM contribution) and a stabilising SIP market share (7% in Q4FY23). The company has among the lowest costs (17.9bps as % of AUM in FY23) of all listed peers, and an improving share of equity assets—up 24% from FY17 to 40% in FY23. If SEBI’s TER proposals go through and ABSLAMC bears it all, we expect its PAT to fall by 20.9%, as per the report.

The asset management industry in India is relatively new and faces a number of risks.  According to the Nuvama report, some of the risks are listed below
a) Protracted weakness in equity markets may blunt inflows and revenues.
b) Regulatory changes such as increased taxation or further reduction in TERs threshold may dampen inflows and revenues.
c) Shift towards ETFs/index funds may hurt revenues as this segment commands much lower fees, or any rise in AUMs on the alternatives side, which may result in cannibalisation of revenues and growth prospects.
d) Increased offtake of insurance and alternative investment products (AIFs, PMS, etc), particularly ULIPs and NPAR products, may result in lower-than-anticipated revenues.
e) Intense competition as several new fin-techs and alternate investment houses are eying huge retail assets, both existing and potential.
f) Any significant underperformance of the schemes of any fund house.
g) Any exit of key management personnel such as CEO, CIO and fund managers.
h) Reduction or exit of stake by any large shareholder.

TERs on asset classes rather than at the scheme level
In the existing regulatory environment, TERs are computed at the scheme level. Generally, this allows for higher overall TERs. The paper proposes to change TERs from scheme level to asset class/AMC level. As regards equity, the paper proposes a maximum TER of 255bps (versus 225bps currently). TERs reduce as the scale increases, with TER for AUM above INR1tn becoming as low as 130bps. Similarly, the TER for non-equity AUM is capped at 120bps (versus 200bps currently).

For hybrid and balanced AUM, SEBI has proposed that the non-equity AUM be subject to the non-equity TER. Accordingly, TERs of hybrid schemes will be the weighted average TERs of equity and debt. The above revision is only for active schemes; no change is proposed for passive products.

SEBI has proposed to include brokerage, GST on fund management charges, and STT in the TER. This may have a large impact on AMCs profits if not passed on to intermediaries. As we understand from asset managers that churn is at least upto 60% of the equity portfolio, as per the Nuvama report.