Regulatory hurdles take toll on AMC stocks

Cap on TER could hit HDFC AMC, Reliance Nippon earnings by 17-25% in FY19

Viewed as the best proxy of the financialisation theme, the initial public offerings of both asset management companies (AMCs) — Reliance Nippon Life Asset Management (RNLAM) and HDFC AMC — were a hit. However, what investors often forget is the regulatory risk—changes brought about by the markets regulator (Securities and Exchange Board of India or Sebi) and the impact it could have on the sector.

After the close of markets on Tuesday, Sebi capped the total expenses ratio of AMCs with equity assets up to ~500 billion from 1.75 per cent to 1.05 per cent. This led to a sell-off in the two listed AMC stocks, which shed 8.5-11.0 per cent on Wednesday. Given that equity schemes form a major portion of the fund houses’ total assets under management (AUMs), the move will have a significant impact on their profits.

Nomura has downgraded RNLAM (third largest AMC) by a notch to 'neutral' —fearing that near-term earnings will remain under pressure — while reducing its target price by 33 per cent to ~210. Likewise, even as Morgan Stanley retained its 'buy' rating on HDFC AMC (second largest fund house), it slashed the firm's earnings per share by 14 per cent to ~1,765.

CLSA estimates that equity accounts for 40 per cent of the sector’s AUMs and 70 per cent of the revenue. The fee cut could, hence, impact sector earnings by nearly 25 per cent. Impact on RNLAM is pegged at 17 per cent, while that on HDFC AMC is estimated at 25 per cent, says CLSA.

Given this is the second fee cut in 2018 and AMCs have already passed on about 70–100 per cent of the earlier cut to their distributors, analysts at Ambit say there is limited room to pass on further pricing pressure to distributors. As of now, a knock to their financials seems inevitable, say analysts.

Apart from frontline AMCs, stocks of brokerages that also operate AMCs, such as Edelweiss and IIFL, lost nearly 5 per cent on Wednesday, while those of Motilal Oswal Financial Services and JM Financial were also in the red. ICICI Prudential Life Insurance — which has 83 per cent exposure to unit-linked insurance policies (maximum in the industry) —lost over 2 per cent on Wednesday.

Notwithstanding Sebi’s move on Tuesday, the year has been quite unforgiving for AMCs. HDFC AMC is trading 22 per cent below its listing price (after a strong listing) and RNLAM's stock has plunged 34 per cent so far in 2018. This indicates that regulatory interventions will remain an overhang, despite financialisation being a unique investment theme for these stocks.