Reliance Nippon Life Asset Management: A diversifier for the long run

Large AUM, wide investor base and rising retail participation should drive growth

A favourable macro environment, buoyant capital market, and growing investor awareness have led to strong flows into the mutual fund industry over the last couple of years. Reliance Nippon Life Asset Management, one of the largest asset management companies in India, has in turn seen healthy growth in revenues and profit over the past four to five years. The AMC’s quarterly average assets under management (QAAUM), revenue and profit after tax, have reported an annual growth of 22 per cent, 18 per cent and 15 per cent, respectively, between FY-13 and FY-17. Reliance AMC is the third-largest mutual fund house in India in terms of QAAUM with a market share of 11.4 per cent as of June 30, 2017.

With real estate and gold losing their sheen as investment options, savings in financial assets such as mutual funds, is likely to rise. Increased retail participation will continue to drive healthy growth of 15-18 per cent in average AUM for the industry over the next two to three years.

That said, mutual funds mainly generate revenue from fees that they charge as a percentage of AUM, known as management fees. The fees depend on a number of factors such as the total value of AUM, regulatory limits and the composition of AUM. Regulatory tweaks such as tightening of fees and commission, further cap on expenses, etc., could impact revenues and hence profitability.

For Reliance AMC, its large AUM base that will help drive economies of scale, a well-diversified investor base with growing share of retail investors, and wide distribution network are key positives that can help weather challenges within the industry better. The company’s profit has ranged between 0.21 per cent and 0.28 per cent of AAAUM (annual average AUM) over the past three years — higher than the overall sector’s average at 0.16-0.18 per cent.

At an expected annual growth of 18-20 per cent in AUM over the next five years and profit to AUM of 0.2-0.22 per cent, earnings for Reliance AMC are likely to grow at 15-17 per cent annually over the next five years. The asking price of the IPO issue is not expensive, when compared to the recent deals in the industry.

Deals such as the buyout of Fidelity India by L&T Finance or Religare by Invesco have happened at 6-7 per cent of AUM. At the upper price band of ₹252, the IPO values the business of Reliance Nippon Life Asset Management at around ₹15,420 crore, about 6.9 per cent of its AUM as of June 2017.

Earlier stake sales by Reliance Capital — Reliance AMC’s promoter — to Nippon Life, however, have happened at a tad lower valuation. In 2015, Nippon Life increased its stake in the AMC to 49 per cent from 35 per cent, at a price that valued the business at ₹8,542 crore, at about 5.6 per cent of its AUM then.

Nonetheless, scarcity premium (no comparable listed player), healthy underlying growth and dominant position in the industry, are likely to draw investor interest. While listing gains may be limited, long-term investors can subscribe to the issue as a good diversifier within the financial services portfolio. DCF valuation indicates 15-20 per cent upside over the long run.

Growth drivers

Reliance Nippon Life Asset Management manages pension funds, offshore funds and managed accounts, including portfolio management services and alternative investment funds (AIFs). The company’s mutual fund quarterly average AUM stood at around ₹2.2 lakh crore as of June 2017.

Reliance AMC manages 55 open-ended schemes and 174 close-ended schemes as of June 2017.

The mutual fund industry has witnessed a healthy growth over the past decade. Debt mutual funds form a predominant share of the overall industry AUM, constituting about 65 per cent of AUM. Debt funds are usually preferred by institutional clients that comprise about 60 per cent of the investor base.

However, over the past couple of years, there has been a growing participation from retail investors. With a large part of the retail portfolio invested in equity schemes, the underlying growth in the retail segment should augur well for the growth in equity AUM.

Reliance AMC’s retail AUM share in the total AUM has grown from 10 per cent in FY13 to 24.6 per cent in FY17. According to ICRA, Reliance AMC has the second highest retail investor share in terms of monthly average AUM. The rate of management fees charged for equity funds is generally higher than the fees charged for debt and liquid funds.

Financial metrics

In FY-17, Reliance AMC’s average fee as a percentage of AUM in debt (liquid), debt (other), equity, gold and ETF stood at 0.09, 0.48, 1.35, 0.95 and 0.19 per cent respectively. Debt funds still constitute the highest portion of AUM for Reliance AMC (around 68 per cent). However, debt funds contribute 39 per cent and equity funds 58 per cent of the total management fee generated by the AMC.

The major costs for an AMC include employee costs, administration, brokerage/commission and marketing costs. Higher proportion of marketing expenses has seen Reliance AMC’s profit margin (as a percentage of AUM) moderate in the last two years — from 0.28 per cent in FY15 to 0.21 per cent FY17.

Risks

Over the years, a number of regulatory tweaks have added pressure to AMCs’ profitability. For instance, AMFI had asked funds to cap upfront commissions at 1 per cent and trail commissions at 1.75 per cent for every year from April 2015. SEBI has capped the total expenses that a mutual fund can charge — at 2.5 per cent for equity schemes and 2.25 per cent for debt schemes.

More stringent regulatory norms can impact the growth and profitability of AMCs. The Bose committee came out with its recommendations in FY-16. One of them was to completely phase out upfront commissions in the distribution of financial products. The committee has also recommended lowering the cap on expense ratio.

Equity dilution

The offer comprises a fresh issue of 2.44 crore shares and offer for sale of 3.67 crore shares by the promoters (Reliance Capital and Nippon Life). Given that the business is not capital-intensive, we believe that raising the ₹616-odd crore of fresh capital will lead to needless dilution.

Of the net proceeds (around ₹616 crore) raised through the fresh issue, about ₹165 crore is proposed to fund inorganic growth initiatives. There are currently 41 active AMCs in the market. Another ₹125 crore has been set aside for lending to Reliance AMC’s subsidiary Reliance AIF.

This loan will be used by Reliance AIF towards investment as continuing interest in the new AIF schemes it proposes to launch. As of June 2017, closing AUM of Reliance AIF stood at ₹1,336 crore.

The remaining proceeds are to be used for setting up new branches, marketing initiatives, towards new fund schemes etc.

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