I expect equity net flows to decline further
Motilal Oswal AMC
Clear perspectives from a straight-shooting business and thought leader:
WF: The MF industry is witnessing a slowdown in inflows and the debate rages whether to attribute this to lower distributor interest consequent to commission structure changes or bruised investor sentiment, or perhaps both. What is your outlook on business momentum for the MF industry in 2019 and what do you see as the key drivers and key challenges in the year ahead?
Aashish: I can imagine that a good part of the decline is related to market uncertainties and the “not-so-great” experience of being invested in equity funds in the last 1 year. We are now in a zone where the last one year returns on a lot of multicap and midcap funds are in the negative and a lot of aggressive hybrid (erstwhile balanced fund) and dynamic funds are in either very low single digit or negative returns territory too. This usually doesn’t augur well for flows. If one analyses equity flows from an average of 20,000 crs a month net in FY18 we are down to average of 11,800 crs a month FYTD19 and the exit number for November 2018 was around 8,600 crs. This is a huge decline on average and even worse as we exit November 2018. In FY18 my sense is that on an average the monthly SIP input value was in the range of 6500 crs while in this year the average has been around 7,500 crs and we exited November with an input value of just under 8,000 crs. In any given month, the net inflow is a function of SIP flows, NFO flows and discretionary flow from investors. What the above numbers seem to suggest is that while SIP flow has been rising and accounting for a larger proportion in our net flows, the NFO numbers and discretionary investment numbers have declined.
If one analyses by product category, one finds that Balanced Funds were doing around 6,000-7,000 crs a month netflow in FY18 and this year that average is in the range < 2,000 crs while we exited November with around 200 crs netflow in the balanced category. This means a good part of the decline in the net sales has come only in this category while the decline in equity proportionately is not as bad as one might initially surmise.
Coming to the commission issue, even though November was the first month of applicability I am quite sure banning upfronts and narrowing the applicability of SIP incentives and B30 incentives has started to bite already by making the business unattractive. That the changes have come about exactly when markets have become challenging is set to be a double whammy.
Coming to business momentum in 2019, I expect MF equity netflows to decline further and I won’t be surprised if we see some months of negative netflows. We have an approximate equity asset base of around 10 lac crs and given this base, there is a natural rate of attrition as investors redeem in the normal course of action or in response to market circumstances or due to maturity of closed ended funds or churn for variety of reasons post exit load period etc. So redemptions continue at a certain pace and if market circumstances become challenging or if past sales practices start haunting the flow behaviour, there could be a further rise in redemptions. Already this year average monthly redemptions are higher than last year’s average for the first 8 months and the inflows are already lower. On the other hand, the cut in TER and resultant reduction in commissions will render the business unattractive for certain sections of distribution resulting in further decline in inflows. This could result in negative net flows.
WF: Counter-intuitively, markets seem to be strong despite political reverses for the ruling dispensation. What is your equity market outlook for 2019 and how do you see FII flows in the coming year?
Aashish: As regards markets, I believe with the developments related to the central bank and with state elections out of the way, we have turned a corner and we are probably primed for a pre-election rally. I am not saying this after seeing the market behaviour but the day the news came and everyone was fearing a market decline, we actually saw the markets start rising. I was asked by a media person what do I forecast. I said there is no point forecasting, market has decided to go up so let’s sit back and see what the market is trying to tell us. The election event is over; the results are not as bad as they are being made out to be and everyone expects state elections and general elections to play out differently, it’s been that way all along in history.
RBI Governor quitting is never a great sign as is reported by media, but equally well it was the same media which kept telling us all through the year that there is a wide chasm between RBI and the markets on where yields should be, we are undershooting inflationary expectations, we are lagging growth expectations, we don’t have credit availability blah blah. With a change of guard at least in the near to mid-term one can expect reduction in rates, better liquidity and a credit push priming economic growth. In the last 3-4 years the biggest challenge is that we never knew where we are in the economic cycle with too many mixed signals and disruptive changes by the Government. Finally we are likely to see a growth cycle with corporate earnings reviving. With some lag effect we may again see inflationary pressures and rising rates and cycle peaking out but that’s some way off, for now we are likely to witness a huge expansionary push and possibly a rip roaring pre-election rally.
Further, I expect FPI flows to be reasonably strong – in all past instances where oil has played truant and the rupee has declined – 2002-03, 2008-09, 2012-13 – with some lag effect FPIs have been big buyers in our markets. The US and a good part of developed markets have witnessed a multi-year rally and hence flows to emerging markets have been poor. With the developed markets likely topping out sometime around the corner, allocation to emerging markets especially like India is likely to rise.
WF: How do you see the upfront ban and TER cuts induced trail rationalization impacting different distribution channels? Which intermediation channels do you see gaining and losing traction in 2019?
Aashish: In my assessment retail segment of banks and some retail IFAs may lose interest in the MF distribution business because of reduction in the commercials. Not because anyone is greedy or that they don’t want to do the business but just because the threshold AuM that is required to sustain the business will go up significantly – when margins decline not everyone is going to find it easy to increase the volumes or be motivated enough to do so. So a lot of people will try to figure that with same efforts how I can preserve the earnings. Many retail IFAs have been anyway engaged in insurance or fixed income products as an alternative all along and they may choose to rebalance their focus and their efforts. As far as retail segment of banks are concerned I perceive that they have multiple options for their customers and that’s more so when interest rates are rising and credit is picking up. Their participation tends to be cyclical. Last 2-3 years were different because of abundant float lying around post demonetisation, low interest rates and poor credit offtake.
On the other hand there are some segments of the markets like stock brokers who are facing pressures in their business and who on relative basis may find our commercials more attractive than their industry so they may want to jump in with enhanced vigour. I can see early signs and trends on each of these.
National distributors, large IFAs, private bankers, wealth segments of banks and other wealth managers may continue because they may choose to respond to what their clients want and for many of them mutual funds are the mainstay. In fact the strong may become stronger out here. Digital channels will continue to rise in popularity for some segment of clients who know what they need. The allure of digital and DIY is here to stay. How many investors can navigate themselves without advice is still to be seen but there will always be people who shift in and out of the advice vs. unadvised zone depending on their experiences and learning trajectory.
In the IFA channel with every shift in the industry regulations may it be introduction of ARN and AMFI exams, the tech bubble of 2000s or the financial crisis of 2008, the abolishment of entry load and introduction of direct plans, each time the big and more importantly the committed ones have become bigger and some smart new entrants have made it big while on the margins a lot of people left the industry. This is part of evolution. We have to keep pace with it. It has happened to AMCs also. Even AMCs have to reinvent themselves.
WF: In the context of questions increasingly being raised on alpha prospects in large cap actively managed funds and persisting fears of ongoing market volatility, which equity products do you see gaining and losing traction in 2019?
Aashish: The alpha challenge is only aggravated in the large cap space because of the restriction of 80% allocation within stock no 1 to 100 by market cap. Other than this category I don’t see any major challenges. I am not in the camp which is carried away with last one year’s alpha related challenges. I think too much hue and cry is being made without noting that 2017 and 2018 have been unprecedented years. In 2017 Nifty, Nifty MidCap 100 and BSE Small were up by 28%, 48% and 57% respectively. I don’t see how one can beat a 50 or 100 or wider based stock index which goes up by 40-50% in a single year and one needs to think what one needs to buy to beat that index in that time frame and are we even supposed to take all the risks to try doing that. Let us imagine, you are travelling from Mumbai to Ahmedabad in Shatabdi Express and the train is traveling at 140 kmph. While you are also sitting inside the train; if I challenge you that you must reach Ahmedabad before the train does, sitting inside the very same train can you reach earlier? So how do you expect your fund manager to beat the market in a year when pretty much the whole market decides to go up 40-50%? Stock picking works when you have to pick stocks, it doesn’t work when the whole market is being picked.
Then comes 2018 where quite confoundingly the Nifty continues its upward trajectory so by the time we are in August 2018, the Nifty is up by 55% in 20 months from demonetization bottom in January 2017 till August 2018. All the same, the MidCap 100 and SmallCap start losing height in January 2018 and they crash 25% and 35% respectively even as the Nifty keeps rising with increasingly narrow breadth. Come September 2018, it doesn’t matter what you own, everything decides to collapse indiscriminately. This kind of unidirectional movement on both sides and wide dispersion in midcap and small cap vs largecap are both unprecedented and unlikely to recur for long time to come. I don’t think we need to sit on judgement about our alpha generating capabilities exactly in this window of time. Let the market return to sanity and let the crowd get a bit more discerning about what’s working and what’s not, then we will see.
On the whole, I don’t yet believe that we have lost our scope of generating alpha. How is it possible when we live in a country where the first insurance company got listed one year back, where banks are still IPOing and where most huge brands are yet smallcap and midcap companies? We have a long way to go. Let’s keep exceling and refining what we know best and lets avoid getting drawn into self-doubt and intellectual debates. For a vast majority of our clients, alpha is outperformance over FD and hence the index is not even a topic of make or break in their investment life. I don’t meant to say we don’t have to justify our fees as active managers, I am only saying too much focus on one item basis a short window of unusual movement doesn’t help especially when most retail clients can’t even relate to it yet. Do we really think our clients are looking for alpha when we are 15% down in small cap funds? No; right? Will the argument fly if I say that I am only 18% down when small cap index is 25% down? When you lose 15-20% of your investment, alpha or no alpha, you are bad. People want returns, period!
WF: What would your message be to IFAs as we move into what promises to be an action packed 2019?
Aashish: On the whole, let me say that while our business may be looking less attractive to some of us, it is going to look a whole lot more attractive to investors; and that is what ultimately matters. Distributors have done a fabulous job all the way, and I don’t see any reason why it won’t continue.
I would say, get used to and be prepared for higher volumes but with lower margins and also lesser competition. Please focus a lot on differentiating your interactions, your offerings, your advice and the whole process of engaging with clients.
Lastly, please do not get carried away with discussions on direct vs regular, advisory vs distribution etc. Please understand which customer segment and what type of customer would prefer a particular type of model. Please be mindful of which type you are catering to and accordingly focus your energies on your offerings. A business model has to be matched to a customer segment and customer type, general discussion about technology, earnings models and product offerings will serve no purpose other than to confuse and disorient.
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