SEBI’s regulatory changes on the total expense ratio (TER) are set to impact the revenue and profitability of asset management companies. Two listed players − Reliance Nippon Life Asset Management and HDFC Asset Management − faced the brunt of the regulator’s move, plunging by 8-11 per cent on Wednesday.

The impact will be greater on equity schemes with a larger corpus of over Rs 10,000 crore, as the cap on expense ratio has been brought down by 25 basis points to as steep as 70 basis points in the case of very large funds.

Players such as Reliance Nippon Life Asset Management, HDFC AMC, ICICI Prudential MF and Aditya Birla MF that have a large number of their top equity schemes with more than Rs 3,500 crore AUM (assets under management) are likely to be impacted the most.

What’s changed?

Mutual funds charge investors for managing their schemes. This charge is called the total expense ratio (TER). Recurring expenses, such as the management fee, distributor commission, registrar fee, trustee fee and marketing expenses total up to TER, which is expressed as a percentage of the assets managed. The NAVs of schemes are declared by fund houses after taking these expenses into account.

The maximum TER that a fund can charge its investors is prescribed by market regulator SEBI. Earlier, equity-oriented funds were allowed to charge a TER of 2.5 per cent. The cap was set lower for debt and index funds at 2.25 per cent and 1.5 per cent, respectively.

SEBI guidelines further set sub-limits for TER based on the size of the assets managed. For equity schemes, fund houses could charge 2.5 per cent for the first Rs 100 crore, 2.25 per cent for Rs 100 crore to Rs 400 crore, 2 per cent on the next Rs 400 crore to Rs 700 crore and 1.75 per cent on any amount above Rs 700 crore.

For debt schemes, the limits were 25 basis points lower in each slabs. As per the revised norms, the maximum TER funds can charge is 2.25 per cent in the case of equity oriented schemes having AUM up to Rs 500 crore (see table).

TER reduces as the scheme AUM increases and is brought down to 1.05 per cent for equity AUMs of over Rs 50,000 crore. While no fund house currently has any equity scheme in the over Rs 50,000 crore category, many have assets in the Rs 10,000-50,000 crore category that will see a 25-70 bps reduction in expense ratio.

For debt schemes, the limits are 25 basis points lower in each slabs.

Impact on profitability

Asset management companies such as HDFC AMC or Reliance AMC generate a substantial portion of their revenue from investment management fees that is charged as a percentage of their AUMs. For instance, in FY18, investment management fees constituted 93 per cent of HDFC AMC’s total revenue.

Investment management fees is normally affected by a number of factors, including level of flows, AUM mix, appreciation or depreciation of the investment portfolios, and also limits imposed by SEBI on TER (as the investment management fee is the residual amount of TER after charging the scheme with other expenses like commissions/brokerages and scheme operating expenses).

Hence, the regulatory changes on TER impact the revenue and profit of AMCs.

For HDFC AMC, its relatively higher proportion of equity-oriented AUM (51.3 per cent as of March 2018) has helped deliver higher management fee. For Reliance AMC, in contrast, its equity portion is a lower 36 per cent of AUM (based on quarterly average AUM) as of March 2018.

HDFC AMC’s net profit as a percentage of AAAUM (annual average AUM) is higher than the others — at 0.26 per cent in FY18 compared with Reliance AMC’s 0.21 per cent and ICICI Pru AMC’s 0.22 per cent.

SEBI’s sharp revision in TER of equity funds is hence expected to weigh on the profitability of top AMCs — the impact could be higher for players such as HDFC AMC that have been enjoying a high fee structure thanks to their higher share of equity AUMs.

A glance at the various top equity schemes across players suggests that HDFC AMC has more funds in the above Rs 15,000 crore AUM category than other leading players. However, HDFC AMC has one of the lowest operating expenses structure (0.29 per cent of AAUM against Reliance’s 0.44 per cent), which can help it tide over the pressure on profitability.

Offsetting impact

The major costs for an AMC include employee costs, administration, brokerage/commission and marketing costs. AMCs may pass on some of the impact on the revenue front to distributors. This can help mitigate the pressure on profitability.

SEBI’s mandate of having to pay all commission and expenses from the scheme alone and not from the AMC/Associate/Sponsor/Trustee, can also help bring down the operating expenses for the AMCs, though it will vary on a case-to-case basis.

Over the long run, the lower expense ratio can help draw in more flows into mutual funds, which should benefit all players. However, in the interim, AMCs may see a 10-15 per cent downside risk to their earnings, dampening investor sentiment.

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