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Investment & Finance Sector Analysis Report 

[Key Points | Financial Year '20 | Prospects | Sector Do's and dont's]

Find Out: The Best Way to Tap into Rising Demand of Lithium in India

  • The financial services sector in India mainly consists of the capital markets (asset management, broking, wealth management, investment banking, depository companies) and non-banking financial companies (NBFCs). The market regulator has also allowed new entities such as payments banks to be created recently thereby adding to the types of entities operating in the sector.
  • The explosion of mobile phones, adoption of technologies such as cloud computing and rising pace of interconnectivity have led companies in the financial services industry to ramp up investment in information technology (IT) to better serve their end-customers.
  • The growth of the financial sector can be attributed to rise in financial inclusion, increasing penetration of financial assets, wider participation in equity markets and technology adoption
  • Rising awareness about benefits of investing in equity markets and growing popularity of ways of investing, such as SIP, are some of the factors contributing to the increased participation of domestic individual investors in the Indian mutual fund industry. The AUM of the mutual fund industry in India has grown at a CAGR of 15.5% over the past five years, with the equity AUM growing at a CAGR of 17.3%.
  • During the last five years, the Indian equity markets also achieved a healthy balance between the domestic institutional investors (largely Mutual Funds) and Foreign Portfolio Investors (FPIs), thereby significantly reducing the skew towards reliance on FPI inflows, lending more stability to the Indian markets.
  • The Indian equity market is expanding in terms of listed companies and market capitalization, widening the playing field for brokerage firms. In FY20, the number of listed companies on NSE and BSE were 1942 and 5461, respectively. Sophisticated products segment within the market is growing rapidly, reflected in the steep rise in growth of derivatives trading
  • The Government of India has taken various steps to deepen the reforms in the capital markets, including simplification of the Initial Public Offer (IPO) process which allows qualified foreign investors (QFIs) to access the Indian markets. India has scored a perfect 10 in protecting shareholder rights in the World Bank's Ease of Doing Business 2020 report.
  • There is a growing opportunity for depository companies (which hold demat accounts of investors) as there is a strong long term structural growth trend in the securities market. According to the market regulator, the number of new depository accounts opened in FY20, was the most in a decade at 4.9 million. It has also become mandatory for unlisted companies to get their shares dematerialized if they issue or transfer shares, offering additional growth opportunities to depository companies. The opportunity size is 60,000 companies.
  • The RBI's Internal Working Group (IWG) recently recommended significant changes with respect to NBFCs stating that large NBFCs with an asset size of Rs 500 billion, including those owned by large corporate houses, may be allowed to convert to private banks subject to completion of 10 years of operations and meeting due diligence criteria and compliance. For payments banks intending to convert to a small finance bank, track record of three years of experience as payments bank may be considered as sufficient.
  • The RBI has also decided to put in place guidelines regarding dividend distribution for NBFCs. Unlike banks, currently there are no guidelines in place. However, it has now been decided by the RBI that different categories of NBFCs would be allowed to declare dividend as per a matrix of parameters, subject to a set of conditions.

How to Research the Investment & Finance Sector (Key Points)

  • Supply
  • Plenty to meet personal finance needs but not enough to meet long-term infrastructure needs.
  • Demand
  • India being a growing economy, demand for long-term loans, especially infrastructure and personal finance is high.
  • Barriers to entry
  • Stringent regulatory norms prevent new entrants. Customers prefer to invest their money with a reputed financial services company offering a wide range of services.
  • Bargaining power of suppliers
  • Low, as the industry is highly regulated by the market regulator and government.
  • Bargaining power of customers
  • Medium. Although customers do not have much bargaining power, they can easily switch to another company based on the terms and quality of services provided.
  • Competition
  • Competition between big players is intense in the industry. Financial services companies often compete on the basis of offering lower financing rates, higher deposit rates and investment services
  • Threat of Substitutes
  • The threat of substitute products—payment services and peer-to-peer lending—continues to threaten the financial industry.

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Financial Year '20

  • During FY20, the Mutual Fund industry's Assets under Management (AUM) as of March 31, 2020 fell by 6% to Rs 22,300 billion as against a closing AUM of Rs 23,800 billion as of March 31, 2019. HDFC AMC, one of the leading asset management companies in the country saw its AUM fall by 5%. The fall in overall AUM can be attributed to the fall in equity oriented AUM, which fell by 19% due to the fall in market, primarily in the month of March 2020.
  • The industry saw net inflows of Rs 800 billion during FY20- Inflows to the tune of Rs 700 billion in equity assets, while debt saw outflows to the tune of Rs 400 billion.
  • The market regulator introduced certain new provisions for valuation of debt and money market instruments
  • During FY20, the exchanges came out with a framework for listing of commercial papers (CPs), in a bid to broaden investors' participation in such securities. In November 2019, Aditya Birla Finance became the first NBFC to list its commercial paper borrowing of Rs 1 billion on the exchanges.
  • The NBFC sector continued to lose its share in the financial services industry as credit growth of Banks continued to moderate throughout FY20.
  • To strengthen the asset-liability profile of the sector, RBI introduced a liquidity coverage ratio (LCR) requirement for all NBFCs with AUM of Rs 50 billion and above. The LCR regulation mandates NBFCs to maintain a minimum level of high-quality liquid assets to cover expected net cash outflows in a stressed scenario
  • During FY20, NBFCs rationalized operating expenses, and resorted to raising capital and financial deleveraging.
  • With a large number of NBFCs access to credit getting squeezed as banks and mutual funds became more wary of lending to the sector, credit growth began to wane as well. Lending to the NBFC sector remained largely restricted to the higher rated entities.
  • Bankruptcy resolution mechanism for NBFCs with assets worth Rs 5 billion or more was introduced under Insolvency and Bankruptcy Code (IBC).
  • During FY20, CDSL closed the year with 599 depository participants offering depositary participant services across 20K locations pan-India - representing 94% pin codes. It also added 2,120 new unlisted companies, taking its headcount to 3,250+ companies. With depository business classified under essential services, all operations of CDSL ran smoothly despite Covid-19 led lockdowns.
  • In October 2020, shares of India's largest registrar and transfer agent of mutual funds- Computer Age Management Services (CAMS) were listed on the exchanges. The IPO comprised of a fresh issue of Rs 1.6 billion and an offer for sale of Rs 1.5 billion by promoters. Chennai-headquartered CAMS provides technology-driven financial infrastructure and services to mutual funds and other financial institutions.

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  • Two-thirds of India's population lives in rural areas where financial services have made some presence so-far. However, rural India has seen a steady rise in incomes creating an increasingly significant market for financial services.
  • There are several standalone networks of Self Help Groups (SHG), Non-Government Organizations (NGOs) and Micro Finance Institutions (MFIs) in different parts of rural India. Cross-utilisation of these channels can facilitate faster penetration of wider suite of financial services in rural India.
  • Increasing use of technology to reach rural India is the paradigm-shifting enabler. Internet kiosk based channels are expected to become the bridge that connects rural India to financial services.
  • Rural credit segment is a large market, which can be tapped by ensuring timely loans that are critical for the agricultural sector.
  • Safe investment options have a potential to tap into rural household savings. Companies can use innovative products like third party money market mutual funds to cater to rural investment needs.
  • Lower mutual fund penetration of 5-6% reflects hidden growth opportunities. Deeper penetration of financial products, better regulation of equity markets, better performance of the funds and availability of simple products via technology are expected to shape the mutual fund industry in the coming years.
  • With the increasing retail penetration in the equity market, there is an immense potential to tap the untapped market. Growing financial awareness is expected to increase the fraction of population participating in this market.
  • India is one of the fastest growing wealth management markets in the world. The regulatory environment for fiduciary duties in wealth management is evolving and financial services companies can expect to benefit greatly from quickly adopting new investor protection measures.
  • Investment in required technologies, imbibing state- of-the-art best practices of advisory and creating customized and innovating products will help enable growth in the sector.
  • As the RBI allows more features between wallets and bank accounts, mobile wallets provide plenty of opportunity to companies to become strong players in the financial ecosystem. India's mobile wallet industry is estimated to grow at a CAGR of 148% to reach US$ 4.4 billion by 2022.

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FAQs on the Investment & Finance Sector

How has the finance sector performed in the past decade and when is a good time to invest in the sector?

The finance sector has been one of the sectors that has driven the stock market rally in the past decade giving returns of more than 200%. While it has lost some of the gains since the pandemic, it has bounced back with over 70% gains.

Finance stocks are very closely linked to economy as both credit growth and margins are dependent on GDP growth and interest rates. NBFCs tend to have high non-performing assets (NPAs) when interest rates are high and economy is underperforming. Adverse fluctuations in financial markets or conditions in the economy can also cause a decline in an AMC's assets under management and vice versa, having a direct bearing on its revenue and profitability.

Therefore, the best time to buy finance stocks is at the start of an economic expansion (in case of AMCs) or when interest rates are lower (in case of NBFCs).

To know more about the sector's past and ongoing performance, have a look at the performance of the NIFTY Finance Index and BSE Finance Index.

Where can I find a list of finance stocks?

The details of listed finance companies can be found on the NSE and BSE website. However, the financial information on these websites can be overwhelming.

For a more direct and concise view of this information, you can check out our list of finance stocks.

Which finance stocks were the top performers over the last 5 years?

CDSL, Bajaj Finance and L&T Finance Holdings were the top performers over the last 5 years in terms of sales and profit growth.

CDSL's growth can be attributed to its position as one of the only two depositories in India with a steadily gaining market share. The last 5 years have been quite good for CDSL with the advent of newcomers into the stock market. As there is a huge spike in the number of new demat accounts being opened, CDSL continues to be one of the biggest beneficiaries of this trend.

Bajaj Finance, with its strong business profile has emerged as one of the largest retail asset financing NBFCs in India, and has grown on the back of its two-pronged strategy of building scale and maximizing profit.

Asset management companies such as HDFC AMC and Nippon Life AMC that have listed more recently have also done very well. The stock of HDFC AMC has given over 40% returns in the last 2 years since its listing.

To know which other companies performed well over the last 5 years, check out our entire list of top performers.

What kind of dividend yields do finance stocks offer?

Since finance companies have to provision for potential bad loans, these provisions generally lower profits for the company. And as dividends are mostly paid from the remaining share of profits once essential expenses are met, not all finance stocks can steer you to handsome dividends.

However, there are some finance stocks that have a history of paying dividends.

To know which are these companies, check out our list of top finance stocks offering high dividend yields.

Which are the finance stocks with the best shareholder returns?

Shareholder returns measure the total returns generated by a stock to an investor. This profitability helps gauge a company's effectiveness when it comes to using equity funding to run its daily operations. In the Indian stock market, Cholamandalam Investment, Bajaj Finance and HDFC are the top finance stocks right now with the best shareholder returns.

To know which other finance stocks offer great return on equity, you can check out the top finance stocks offering the best shareholder returns here.

Which are the best finance stocks to invest in currently?

Investing in stocks requires careful analysis of financial data to find out a company's true worth. However, an easier way to find out about a company's performance is to look at its financial ratios.

The most commonly used valuation ratio for non-lending finance businesses (AMCs or Demat companies) is the Price to Earnings ratio while the most commonly used valuation ratio for lending businesses (NBFCs or Housing Finance companies) is the Price to Book value ratio.

  • Price to Earnings Ratio (P/E) - It compares the company's stock price with its earnings per share. The higher the P/E ratio, the more expensive the stock.

    To find stocks with favorable P/E Ratios, check out our list of finance stocks according to their P/E Ratios

  • Price to Book Value Ratio (P/BV) - It compares a firm's market capitalization to its book value. A high P/BV indicates markets believe the company's assets to be undervalued and vice versa.

    To find stocks with favorable P/BV Ratios, check out our list of finance stocks according to their P/BV Ratios