Increased regulatory risk to weigh on the AMC sector: IIFL Capital Services

22 May 2023 , 11:24 AM

In a consultation paper, SEBI has proposed to bring all expenses within the scope of TER and have move from scheme-based TERs to asset-level TERs at the firm level. To part cushion the impact of all expense inclusion – it has proposed to increase slabs of Equity TERs. Given its relatively lower Equity AUM base, UTI AMC is likely to benefit from new TER structure and hence will not see any earnings cut. With final regulations pending, analysts at IIFL Capital Services have not changed their estimates but have lowered their  target multiples, given the unpredictability of earnings. Increased regulatory risk (periodic intervention) and earnings uncertainty would continue to weigh on stock performance in near term.

SEBI consultation paper aims to lower costs

SEBI has published a consultation paper reviewing Total Expense Ratio (TER) charged by AMCs to unit holders. Proposals are in line with what has been reported in media over the last 4-5 months. Overarching framework of proposed regulations can be summarized as: 1) TER should cover all expenses. 2) Economies of scale accrue at AMC level; not just at scheme level. 3) Distributor incentives to be re-aligned to curb mis-selling 4) Expense ratio to be linked to performance – introduction of performance-based schemes (voluntary for now; the idea is to reward AMCs only if they outperform benchmark/hurdle rate). The regulator has invited stakeholders’ comments on the paper (submission deadline — 1-Jun-23).

Subsuming all expenses in TER; moving to asset-level TER

Among key proposals – SEBI has proposed to: 1) Subsume – GST on management fees and brokerages (including STT) in TER 2) B30 incentives to distributor will come from investor awareness fund, instead of TER 3) Moving from scheme-level TERs to asset-level TERs (equity and non-equity; no change in Passives TER). In the consultation paper, SEBI highlighted that the difference between Base TER and All Expense TER was 40-45 basis points for the Equity and Hybrid segments in FY22. To smoothen the impact of absorption of this additional cost – SEBI has proposed to raise TERs of Equity – new proposed range of 1.3%-2.55% versus 1.05%-2.25% earlier (though not strictly comparable). As for Debt, SEBI has proposed to cut TERs from the current 0.8%-2.0% to 0.9%-1.2%. However, this would not impact AMC profitability as the industry’s current debt TER (0.77% in FY22) is below the new proposed rates. Although analysts at IIFL Capital Services see headroom for augmenting debt TERs, this would still be challenging — given the high competition and low return on debt products. 

Earnings impact to vary; TER to benefit smaller AMCs

Impact on AMC earnings would vary, based on: 1) AUM size (the proposed slabs ensure smaller AMCs are not at disadvantage) 2) Portfolio turnover (as brokerages and STT are now included in TER) 3) Hybrid funds’ share in total equity AUM mix (TER changed from pure equity to debt-equity mix in proportion of AUM). Finally, earnings impact would also depend on AMCs ability to pass-on TER cuts to the value chain (distributors, brokers and RTAs).

Worst-case EPS impact of 30-35% for listed AMCs, barring UTI AMC

IIFL’s assessment of likely impact on AMC earnings is based on 3 factors: 1) Change in TER (scheme to asset level) – including impact of GST inclusion and exit incentives 2) Inclusion of brokerage cost and STT in TER 3) Impact of change in hybrid TER. As debt TERs are lower than permissible limits, analysts at IIFL Capital Services are focusing on likely changes in equity TERs. Firstly, for change in TER – they are comparing total TER (includes incentives and GST) of April 2023 with the proposed rates. They find that HDFAMC may see a 13 basis points reduction in blended Equity TERs; as against this, Nippon and Birla would see only marginal impact of 2 basis points each; UTI AMC may see 13 basis points rise. Difference in yield is on account of AUM size and scheme concentration. In order to estimate the impact of brokerage costs (including STT), analysts at IIFL Capital Services analyzed the March-April portfolio turnover of each AMCs — Nippon AMC has the highest turnover, followed by Birla AMC and then HDFCAMC and UTI AMC. Resultantly, they are now building 10-18 basis points impact for all AMCs based on their portfolio turnover. Lastly, analysts at IIFL Capital Services estimate the impact of lower TER in hybrid scheme, given that debt will be charged at lower rate now – on TER difference and share of hybrid in total equity AUM. At 35%, HDFCAMC has the highest share while others are around 15-17%. Basis this, the estimated impact is 2-5 basis points across AMCs (highest for HDFCAMC). Collectively, this has led to 28 basis points cut in equity TER of HDFCAMC, 22basis points for Nippon AMC, 20bps for Birla AMC and no change for UTI AMC. Hence, probable full-year EPS cuts would be 30-35% for the 3 AMCs, assuming 100% of the impact is absorbed by AMCs (no EPS cut for UTI AMC).

 

Increased regulatory uncertainty to weigh on sector valuations

SEBI has invited comments on the consultation paper, although analysts at IIFL Capital Services do not expect any significant alteration from the draft paper. With finalization of regulations pending, they have maintained their estimates. As such, SEBI has proposed 6-month timeframe to implement new regulations and thus, impact of new regulation at the earliest would be effective from 1^st January 2024 (FY25 will be the first year of full impact on earnings). Furthermore, although AMCs maintain that impact of TER cuts would be passed-on, quantum would be known only once actual TER cuts are finalized. Nonetheless, considering the significant earnings risk (15-18% assuming 50% will be passed on), analysts at IIFL Capital Services have lowered their target multiples to account for earnings uncertainty. They now value HDFCAMC at 25x 2YF EPS (TP cut from Rs. 2,150 to Rs. 1,950) and ABSLAMC at 15x 2YF EPS (40% discount to HDFCAMC) (TP cut from Rs. 410 to Rs. 370). CAMS, which derives 90% of its revenues from AMCs, would also see pressure on its MF yield – analysts at IIFL Capital Services have cut its target multiple to 30x 2YF EPS (TP cut from Rs. 2,700 to Rs. 2,300). Increased regulatory risk (periodic intervention by SEBI) and earnings uncertainty likely to weigh on stock performance in near term.