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  • JULY 26, 2018

How You Can Profit from this Financialization Trend in India...

What's buzzing in Indian stock markets this week? I'm sure you would have not missed this headline:

  • HDFC Asset Management Company to launch its Rs 28 billion IPO on 25 July.

There are many reasons for the hype around this IPO.

On a macro level, investors across the world are closely tracking the Indian market. That's because it has been one of the most attractive emerging markets lately.

The way Indians invest their money has gone through a very big structural change. And asset management companies (AMCs) are one of the major beneficiaries.

As we seem to be in a low interest rate regime, a lot of money which was lying in bank accounts moving into mutual funds.

What's more, a lot of investment which used to go into physical assets, whether gold or real estate, is moving into financial assets - a lot of it through the SIP (systematic investment plan) route into mutual funds.

Until a few months ago, it was hard to play the Indian financial story. There were no listed Indian AMCs. But now with AMCs coming up with IPOs, new opportunities are set to open up.

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Why AMCs Are Set to Benefit

Mutual funds have a great compounding business. AMCs' growth in their assets is embedded in the underlying investments.

The capital requirement for mutual funds is low and these companies can scale up without pumping in more than the minimum capital prescribed by the regulator.

With buoyant capital markets and the mutual fund industry on a roll, AMCs are eager to hit the market with their initial public offerings (IPOs).

Soon you will be able to invest in the shares of these AMCs. Many are expected to follow HDFC AMC. This opens up an entirely new segment for investors.

The first mover in this race was Anil Ambani promoted Reliance Nippon Life Asset Management Company that came up with a Rs 15.4 billion offering in October last year.

Interestingly, UTI AMC has also announced plans to list this financial year.

The AMCs' plan to go public follows a growing trend where banks and financial services are looking to unlock value in group businesses after the rapid rise in stock markets.

Apart from AMCs, another segment that's grabbing attention is brokerage houses.

And for good reason.

First, with the Nifty crossing the 11,000 mark, investor interest has held up well.

Interest from domestic investors, high net worth individuals, and retail investors towards equities increased due to demonetisation which shifted money towards financial assets and the fall in interest rates which made fixed deposits unattractive.

This is evident from the data...

Spectacular Financial Performance of India's Top 3 Broking Companies

There seems to be value-buying happening in brokering and related stocks. This is due to the stupendous financial performance of the leading companies in this segment.

Net profits of all three major broking companies have zoomed in FY18.

Net profit of Motilal Oswal, Edelweiss Financial Services, and Geojit Financial Services grew 220%, 115% and 95%, respectively over the three years.

Zooming Net Profits

Also, here's a look of how these companies fare on the valuations front.

Key Metrics of Brokerages

CompanyPriceP/E Ratio P/B Ratio Market Cap (Rs million)
Motilal Oswal796.621.34.1115,429
Edelweiss Financial285.624.73.2222,996
Geojit Financial80.024.44.417,904
Source: company reports, Equitymaster database
*Price as on 18 July 2018

Beating the Benchmark

Also, brokerage houses have beaten the benchmark BSE 200 index by a huge margin over the past two years.

Brokerage Stocks Have Beaten the Index

How Mutual Funds and Brokerages Complement Each Other...

The money garnered through IPOs, and inflows into mutual funds are a testimony to heightened investor interest.

And higher interest means more business for brokerages. Fortunes of stock brokers' core business are linked to the fortunes of the stock market. It is natural that the broking industry's business goes up with the market.

Second, in a bullish market, such as the one we are in right now, brokers' profits grow faster than their revenues.

This is because most of their costs are fixed in nature and, therefore, a major part of the new, additional revenue gets converted into net profit.

Additionally, the shift from phone-based trading to online trading is also helping brokers acquire more accounts and earn higher profits.

Mutual Funds - Emerging from the Ashes

Indian households have traditionally favored real estate and gold as means of investments. Growing financial awareness has led to a rise in financial savings of late. However, mutual funds still have a lot of catching up to do among savings in financial assets. What this implies is that the mutual fund industry in India is still in the nascent growth phase, attracting less than 4% of the population's savings. And that the industry's untapped potential is huge.

Poor Mutual Fund Penetration in India

At the same time, the AUM of the mutual fund industry have nearly doubled in the past two years, from Rs 10.8 trillion in 2015 to Rs 19 trillion in May 2017.

Look at the chart below. It shows tepid investor participation in the Indian stock markets until FY14. But starting from the financial year 2014-15 (FY15), there's a paradigm shift in investments by mutual funds.

The Phenomenal Rise of the Retail Indian Investor

The year 2017-18 (FY18) saw another massive leap in net investments by mutual funds. This was, to quite an extent, triggered by the demonetisation drive and then further propelled by the bull rally in the stock markets.

What does all of this indicate?

The mutual fund industry in India has huge scope for growth and development.

Real estate and gold have become less attractive forms of investments post notebandi.

The reduction in bank deposit rates in the past year has led to a shift in investment to mutual funds and the stock markets.

Ankit Shah, the Editor of Equitymaster Insider, has pointed out how domestic investors have made a beeline to invest in Indian equities like never before.

He presents some compelling market data which shows city-wise trend in AUM of mutual funds between 31 March 2015 and 31 Dec 2017.

Here's an excerpt from his study...

  • "Between FY01 and FY15, foreign investors were consistently above the mutual funds, except in the financial year 2008-09 (FY09). That was the only year in the 15-year period when mutual funds were net buyers in the face of an exodus by foreign investors in the aftermath of the global financial crisis.

    But the dominance of foreign investors has been challenged since FY16. The net investments by mutual funds have exceeded foreign investor inflows in two of the last three financial years.

    This is the reason why markets have remained relatively buoyant despite the heavy selling by foreign investors in recent months. Had it not been for the steady domestic investor inflows, the markets would have been in a deep correction."

The Big Question: Will this Trend Continue?

While all of this is well and good, a question in point is whether this positive trend continue? If they do, how will it play out for these financial stocks and upcoming IPOs?

Despite these positives, many of the broking companies have been unable to gain traction. This can be attributed to the low penetration of equities, low ticket sizes, and low frequency of trading among retail investors.

Nevertheless, with buoyant capital markets and the mutual fund industry on a roll, asset management companies and brokerages are eager to unlock value through initial public offerings.

But how should you think about these IPOs? Are valuations worth it? Is the opportunity of a lifetime or the dud of the decade?

These are the questions that will require much more contemplation. But don't worry - our research team is on it.

We at Equitymaster believe a merit-based selection, primarily including valuation, business, and management quality, is the logical way to go about investing in IPOs. If it means going against the herd, so be it. And going by recent past, this strategy has been proven to be successful more often.

To know how to safely profit from the ongoing IPO rush, download this FREE report now and discover How to Get Rich with IPOs.

Also, we will be releasing detailed notes on these upcoming IPOs - keep an eye out for them. You can read our detailed analysis of the upcoming IPOs here.

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