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The fund, which took over the assets of Standard Chartered Mutual Fund in May 2008, is finding the going tough after recent regulatory changes and commercial pressures
Regulatory changes and commercial compulsions are beginning to take a toll on the large number of asset management companies (AMCs) running mutual funds (MFs). Many of them are losing money and see no light at the end of the tunnel given that selling MFs has become tougher and at the same time operational costs have shot up since last year. "At least 10 AMCs are up for sale," says the CEO of a mid-size AMC. The pressures are so strong that two large fund companies are also looking for exits. One of them is IDFC Mutual Fund. The group's top management has apparently decided to get out of the mutual fund business. IDFC does not appear to have formally appointed an investment banker for this transaction. It is exploring its exit options right now and is trying to get a sense of how much it could be valued at. Moneylife contacted IDFC about the possible sale but at the time of writing this article, it did not respond to our query.
Interestingly, IDFC took over the assets of Standard Chartered Asset Management Company in May 2008 to expand into what seemed like a fast-growing business at that time. According to reports, the transaction was valued at $205 million or Rs830 crore. Since the assets it took over were around Rs14,000 crore, it paid about 5.9% of assets under management (AUM), the most popular way of valuing mutual fund takeovers. Under IDFC, the AUM has dramatically doubled to around Rs27,000 crore. It has some 38 equity schemes and 87 debt schemes.
There are 38 AMCs in India, which have received regulatory approval and are operational. Many of them suddenly now find that their business model is not very robust under the changed regulatory regime brought about by the Securities and Exchange Board of India (SEBI). In the middle of last year, SEBI had banned charging mutual fund investors entry loads, which were as high as 6%. The funds used to pay front-end commissions from entry loads, which acted as incentives for distributors to sell mutual funds. Once the entry loads and therefore, front-end commissions were removed, sales of funds fell sharply because distributors had little clear incentive to sell funds. Apart from front-end commissions, distributors also make money through what is called trail commissions of about 0.5%, which is much larger in absolute terms than the front-end commissions because the amount is based on the total assets. However, the rules as to who would get the trail commission (the new distributor or the old in case) was not clear for a long time and distributors still don't see the fact that they can build a strong business solely out of trail commission over a long period of time. In an unprecedented situation, to sell funds, AMCs have now started offering incentives out of their own income-the asset management fees of 1%. In this game, AMCs that don't have natural strength in distribution are worse off. While IDFC is one of the larger operations, it is handicapped vis-à-vis funds like ICICI Pru or HDFC, both of which get their group banking associate to sell their funds through their large and powerful branch network. It was on this strength and also some surreptitious incentives that Axis Mutual Fund managed to raise some Rs1,000 crore from its new fund offer in January this year. IDFC has a wide product portfolio but does not have a bank or an insurance company in its fold.
Parallel to the regulatory pressures, the cost of operations of the fund business has gone haywire. In 2009-10, a year of the massive bull market, the average salary hike was 20%. Lower income and higher costs have made the business unviable to all but the very large AMCs. One more major blow would be the tax changes proposed under the Direct Tax Code (DTC) that makes short-term capital gains fully taxable and long-term capital gains party taxable.
These pressures are too much for many small fund companies but it would be significant if IDFC or any other fund decides to exit the business.