IPO. Should you subscribe to the IPO of UTI AMC?

Over the past five years, the performance of the mutual fund industry has been led by a bittersweet medley of events and market conditions.

If increasing awareness about benefits of investing in equity/debt markets, growing popularity of mutual funds, and sanguine market conditions helped draw in retail investors, the credit crisis post the IL&FS debacle in late 2018, followed by a series of credit defaults and downgrades proved the antithesis of the exuberance, and dampened investor interest.

The performance of active equity funds vis-a-vis their benmchmarks, too, didn’t help the investor cause.

Regulatory changes undertaken by SEBI over the past two to three years, with respect to upfront commission, categorisation norms, and changes on the total expense ratio (TER) front, among other tweaks, have also impacted profitability of players.

The ongoing Covid-19 pandemic has amplified some of the industry’s challenges as equity markets plummeted in March, impacting AUMs (assets under management), and the Franklin episode triggered redemptions in debt funds.

It is against this backdrop that investors need to evaluate the initial public offering of UTI Asset Management Company (UTI AMC). At the upper price band of ₹552-554 per share, the asking price appears reasonable. The IPO is priced at 5.3 per cent of UTI AMC’s mutual fund quarterly average assets under management as of June 2020 (QAAUM).

The other two listed players, HDFC AMC and Nippon Life AMC, trade at a higher 12.6 per cent and 8.6 per cent of their QAAUM, respectively, as of June. On a price to earnings basis, too, UTI AMC’s IPO — priced at 25 times FY20 earnings — is cheaper than the 35-37 times its peers trade at.

Valuation

But there are several reasons why investors need to take UTI AMC’s optically cheaper valuations with a pinch of salt.

One, the AMC’s financial metrics are on a weaker ground relative to its peers.

UTI AMC’s ROE has been 9.8-15 per cent over the past three fiscals. HDFC AMC sports an ROE of 35-40 per cent, while Nippon Life AMC’s ROE has been 16-19 per cent.

Two, UTI AMC has been steadily losing market share in recent years — down to 5.4 per cent as of June 2020 from 8.2 per cent in March 2014 (based on QAAUM).

While there are 41 AMCs in the market, the industry is highly concentrated with the top five AMCs constituting about 58 per cent of the market. UTI ranks eighth among the AMCs in term of QAAUM as of June 2020, according to CRISIL.

Three, UTI funds across equity and debt have been mediocre performers in recent times and hence redemption pressures and weak inflows can impact teh AMC’s overall AUM.

Mutual funds mainly generate revenue from management fees they charge as a percentage of AUM. Muted growth or decline in AUM can hurt earnings. Hence, the asking price of the IPO may turn pricey if the company’s AUM shrinks further this year.

Lastly, a large portion of UTI AMC’s QAAUM is concentrated in a small number of funds — top six active equity funds constitute about 75 per cent of total active equity QAAUM. Large redemptions can be a cause of worry.

Retail investors with low to moderate risk appetite can skip the issue and watch out for trends in market share, profitability and diversification before investing. The recent upbeat IPO market may, however, lead to listing gains for high-risk-takers.

The issue is a pure offer for sale of 3.89 crore shares, with SBI, LIC, PNB, BOB and T Rowe Price International offloading partial stake in UTI AMC.

Business

UTI AMC and its subsidiaries manage domestic mutual funds, provide portfolio management services (PMS) and manage retirement funds, offshore funds and alternative investment funds. As of June, its total QAAUM for domestic mutual funds stood at around ₹ 1,33,630 crore, while its other AUMs (which include PMS and NPS assets) stood at ₹8,49,390 crore.

The PMS business comprises discretionary PMS to the Employees’ Provident Fund Organisation, the Coal Mines Provident Fund Organisation, the Employees’ State Insurance Corporation and the National Skill Development Fund. It also comprises discretionary PMS to HNIs, non-discretionary PMS to Postal Life Insurance and advisory PMS. Of the ₹6,97,000-crore PMS AUM as of June, about 85 per cent is the corpus of the Central Board of Trustees, EPF (received approval to manage since last year).

Both the PMS and NPS (retirement solutions) contribute a minuscule portion to the consolidated income (about 3 per cent).

The chunk of the company’s income comes from management fees related to domestic mutual fund AUM. The rate of management fees for equity and hybrid funds are generally higher than the fees charged for income and liquid funds.

For UTI AMC, income (debt) funds (excluding liquid and money market) constituted 31.5 per cent of total QAAUM in FY18. However, in FY19, post the credit crisis, the AMC’s credit funds were impacted, leading to reduction in income funds AUMs.

The pain has continued and the share of income funds in the AMC’s total QAAUM fell to about 14-14.5 per cent in FY20.

As a result, the share of equity AUMs has gone up significantly during this period, but led by sharp growth in passive funds (that fetch lower management fees) rather than active funds.

In FY19 and FY20, UTI AMC’s revenue from operations fell, mainly due to reduction in AUM of its credit funds.

In FY20, the pain was accentuated by the Covid-induced market fall in March. In the June quarter, the recovery in equity market aided revenues (increased net gains on fair value changes), though it was partially offset by the fall in management fees owing to fall in QAAUM.

While UTI’s high concentration in B30 markets among the top 10 AMCs is a positive (additional TER of up to 30 bps for inflows from beyond top 30 cities), falling market share is a concern. From nearly 30 per cent of total closing AUM as of March 2018, share of B30 reduced to about 24 per cent in FY20 for UTI AMC.

Higher proportion of employee expenses has resulted in lower operating profit margin (as a percentage of AUM) for UTI AMC at 21-22 bps as against 41 bps for HDFC AMC (in FY20).

Reducing costs significantly will be critical for improving the earnings profile for UTI AMC.