Indian asset management industry on high growth trajectory

* Industry to grow at 33% per annum taking assets under management (AUM) to US$350- US$440 billion by 2012

* Retail and portfolio management services to drive profitability

Mumbai, 10 March 2008 : A new report, "Indian Asset Management: Achieving Broad-based Growth" by the Financial Institutions practice of the leading management consulting firm, McKinsey & Company discusses the outlook for the asset management industry in India. It states that the total assets under management (AUM) could grow at around 33 per cent year-on-year from US$92 billion in March 2007 to US$350-US$440 billion by 2012. The research states that while all asset classes and segments in the industry will contribute significantly to growth, retail mutual funds (MFs) and portfolio management services (PMS) will be the key drivers of profitability for AMCs.

Over the last few years, the industry has grown at a scorching pace of 47 per cent per annum albeit on a small base of US$19 billion. Although on metrics of penetration such as AUM as a percentage of GDP and AUM as a percentage of bank deposits, the Indian market appears nascent, it is important to recognise that the industry has progressed significantly on several dimensions in a very short span of time. These include product innovation, quicker turnaround time in servicing customers and the emergence of three important third-party channels in open architecture - banks, national distributors (NDs) and independent financial advisors (IFAs).

According to the report, the retail segment could grow at a compounded annual growth rate (CAGR) of 36-42 per cent annually, taking the total AUM from US$36 billion in 2007 to US$160-US$200 billion in 2012. Rising incomes and increasing demand for wealth management services will drive this growth. This in turn will increase the propensity to purchase mutual funds and result in higher penetration of MFs into tier 2 cities. The research suggests that mass affluent* segments in top 8 cities** and the broad retail segments in tier 2 and tier 3 cities will be the key growth drivers.

"In the domestic market in 2007, the retail and PMS segments accounted for a bulk of the profits. 75 per cent of the AUM and about 95 per cent of the retail profits were realised from the top 8 cities. However, with increasing investments by players, we expect the share of top 8 cities by AUM to come down to 60 per cent and profits to come down to about 80 per cent as the next tier cities show the potential to grow at a faster rate. To achieve this significant investments in infrastructure and customer education will be essential," said Joydeep Sengupta, Director McKinsey & Company and leader of South East Asia and India Financial Institutions Practice.

Likewise, institutional investments are likely to witness a 25-33 per cent CAGR, with total assets under management increasing from US$42 billion in 2007 to US$160 billion by 2012. As in the past, large and mid-sized corporations will be the dominant players.

"Participation of several players such as PSUs, pension funds, insurance companies will be shaped by the regulations and could substantially boost the assets under management. This will also shift the mix to more profitable products rather than largely liquid funds," said Naveen Tahilyani, Partner, McKinsey & Company and co-leader of the Financial Institutions practice.

In addition, buoyant economic growth will attract participation from the international investment community across retail (both NRI and others) and institutional segments. AMCs will tap this through a variety of plays- owned presence, distribution tie-ups and advisory models across key overseas markets such as US, UK, Middle East, HongKong, Singapore and Japan. In 2007, across all funds, not just Indian AMCs, size of India-focused funds is already US$80 billion.

"Going forward, we expect traditional, simple products to drive the growth as about 9-10 million new customers are expected to enter the market in the next five years. This has also been the experience in several other markets including the US, where 75 per cent of AUMs are in simple traditional products. However, certain new products such as real estate mutual funds (REMFs) and dedicated infrastructure funds (DIFs) in particular have the ability to significantly add to the industry growth," said Tahilyani.

"Given the convergence of MF and insurance products (driven by ULIPs), we believe there is a strong case to ensure parity in product features and distribution commissions. A benchmarking of the products and our proprietary customer research shows that today the insurance products have significant advantages. For end-customers ULIPs are seen as investment products that are more transparent, safer and offer various tax benefits. As a result, ULIPs are formidable competitors for the mutual funds industry. AMCs will need to work to create a similar perception for their products," said Sengupta.

McKinsey's proprietary research of investors reveals that the single largest factor influencing customer purchase is the recommendation received from the sales channel. Distribution remains the biggest factor for success. While banks are the most important channel in the top 8 cities, IFAs are increasingly becoming important beyond these cities.

However, brand building is becoming critical as well. Several high performing funds in India have seen outflows or below market growth over the year 2007 clearly establishing the fact that performance alone is not enough and has to be backed by a strong brand. This phenomenon is also clearly observed in other markets such as the US, where strong brand equity helps create a strong perception of performance in the minds of the customers and the channels.

The MF industry in India is more profitable than most other developed markets. The research suggests that as competition increases prices will be rationalized and in turn reduce overall profit margins. In several mature markets, most elements of pricing are deregulated and India is expected to move to the same regime.

"Talent, particularly for fund management of products such as PMS which require high customer touch and complex interactions while providing advisory services, will be a bottleneck for growth. Winners will be those that invest in building the IFA channel and working with partner banks and distribution houses. AMCs which will crack the model of leveraging the large networks of PSU banks for distribution are likely to reap significant benefits," concluded Tahilyani.

About McKinsey & Company

McKinsey & Company is a management-consulting firm that helps leading corporations and organizations make distinctive, lasting and substantial improvements in their performance. Over the past eight decades, the Firm's primary objective has remained constant: to serve as an organization's most trusted external advisor on critical issues facing senior management. With consultants deployed from about 90 offices in more than 50 countries, McKinsey advises companies on strategic, operational, organizational and technological issues. The Firm has extensive experience in all major industry sectors and primary functional areas as well as in-depth expertise in high-priority areas for today's business leaders.

* Income segments are classified as follows - the mass segment, comprising households with annual income of less than Rs 270,000; mass affluent: households with annual income between Rs 270,000 and Rs 675,000; affluent: households with annual income between Rs 675,000 and Rs 2.7 million; and HNI: households with annual income more than Rs 2.7 million.

** Tier 2 cities: 9-100 cities, Tier 3 cities: 100-500 cities. Ranking according to Census definition