Falling yields put the squeeze on fund houses' bottom line in Q3

Shares feel the pressure as analysts cut earnings estimates

Falling yields have weighed on the bottom line of asset management companies (AMCs) during the quarter ended December 2021, prompting analysts to cut their earnings forecasts and price targets.

Three fund houses of the four listed AMCs have seen their net profit decline between 3 per cent and 18 per cent, despite healthy growth in revenue.

Newly listed Aditya Birla Sun Life AMC has managed to buck the trend with 27 per cent growth in profit. However, that was underpinned by a reversal of the employee stock option plan provision.

So what is putting pressure on profitability?

Regulatory changes, growth of low-yielding passive products, and increase in distributor commissions to increase market share are some factors putting pressure on yields.

Markets regulator Securities and Exchange Board of India (Sebi) has enacted several changes aimed at bringing down the cost of investing by lowering the so-called total expense ratio (TER) and improving investor experience. This was reflected in the financials of four AMCs during the recently concluded December quarter.

Analysts expect the pressure on yields to continue, even though it will be partly offset by superior growth in assets under management (AUM).

In a recent note on Nippon AMC, CLSA has said, “Management highlighted yields pressure due to: 1) increased scheme size leading to lower TERs, according to Sebi regulations, 2) lower profitability of new AUMs due to prior regulatory changes, and 3) higher competition leading to increased distributor commissions. We believe the impact of 1) is manageable/gradual and that 2) is largely getting into the base with faster equity AUM growth and even for 3), the management believes the impact is transitory, but we build in slightly lower equity yields. We thus cut earnings per share estimates 2-4 per cent, as these are partly offset by lower operating expenses (opex).”

Mutual funds (MFs) are permitted to charge certain opex for managing a MF scheme, such as sales, marketing, administrative expenses, transaction costs, investment management fees, and registrar fees.

All such costs for running and managing a MF scheme are collectively referred to as TER, which is a percentage of the fund’s daily net assets.

The maximum TER a MF can charge decreases as the size of the fund increases. So, while the smallest equity funds can charge a TER of as high as 2.25 per cent, the maximum TER drops to just 1.05 per cent in the case of equity funds that have an AUM greater than Rs 50,000 crore.

In the past few months, the MF industry has seen a sharp surge in assets as investors continued to invest, despite volatility. Equity assets in the third quarter stood at Rs 13.33 trillion, against Rs 12.79 trillion in the second quarter of the current financial year (2021-22).

The pressure on yields has seen Nirmal Bang derate HDFC AMC and cut its target price (TP).

“…even though the share of equity AUM may increase, competitive pressure on yields could offset the benefits. Taking multiple headwinds into account, we cut our earnings multiple to 30x (1HFY24E) and revise down our TP to Rs 2,516,” it said in a recent note.

ICICI Securities expects Aditya Birla AMC’s operating yield to compress from 43 basis points (bps) to 39.5 bps between 2020-21 and 2023-24.

The market seems to have taken note of the pressure on profitability faced by AMCs. Shares of all listed AMCs have sharply underperformed over the past six-months.