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RIA regulations: lull before the storm

Sunil Subramaniam, CEO, Sundaram Mutual

26 December 2017

In a nutshell

Some media reports suggest that SEBI will announce its much awaited RIA 2.0 regulations on Dec 28th. Whether Dec 28th is indeed the chosen date or some time in 2018 will be seen as more opportune, Sunil believes we are in a lull before the impending storm for MFDs who need to align their business models in a manner that segregates advice from distribution. Sunil takes us through the several milestones that Sundaram Mutual crossed in 2017, his plans for 2018 and the road ahead for intermediation and for a digitized industry.

WF: The industry is closing a great year in terms of business growth and equity performance, with only debt funds disappointing due to recent volatility. What is your prognosis for equity and debt markets for 2018?

Sunil: Lets take prognosis for debt markets first. We think that interest rates will remain a little elevated and we might see a rate hike towards the end of 2018. Inflation is inching up largely on the back of supply side pressures - food inflation, oil prices etc. We expect that in the coming months, demand will increase on the back of higher consumption and that can put further pressure on inflation. When demand starts impacting inflation, RBI typically considers a rate hike. In this context, our view is that the shorter end of the curve is where one should be in 2018 and that longer duration income and gilt funds will continue to face some challenges in 2018.

On the equity side, our expectation of revival in consumption will mean revival in corporate earnings. While RBI may consider a rate hike in 2018, we believe there is still room for some rate transmission at the retail end, which can keep consumer borrowing costs in check. Earnings revival will be very visible in the large caps space in 2018. Among mid and small caps, we believe companies that are executing Government infrastructure projects will see order books swelling as the pace of execution is stepped up - and this will continue to provide good opportunities in the mid and small caps spaces in 2018 not just in infra companies but all businesses that feed into infra - like cement, steel, corporate banks etc.

WF: How concerned are you about a mean reverting correction, considering that valuations remain stretched?

Sunil: We are not very concerned about this, since we see earnings revival happening in 2018. If earnings were to remain flat in 2018, one would be worried - but we don't think this will be the case. FY 18 should be a low double digit earnings growth and FY 19 should be closer to an 18% earnings growth.

WF: To what extent is the significant increase in the industry's retail penetration a secular move and how much should we attribute to the normal cyclicality of our industry which has historically followed equity markets?

Sunil: While the impact of strong equity markets on inflows cannot be denied, we believe there is a fundamental structural move that's happening - which is a shift down of the Indian economy from an inflation band of 7-8% to a lower band of 4-5%. A lower inflation environment has meant that traditional investment asset classes like property and gold have not done well - which prompts investors to consider equity markets. This time - unlike the 2005-2007 period - good equity performance is happening in a low inflation environment. The difference in performance of equity vs other asset classes is quite stark - which sets the base for a structural shift of savings towards financial assets.

The second factor - and I think the industry and our distributors can take credit for this - is the sharp focus on promoting SIP as the best equity investment strategy. The huge success of SIPs automatically serves to reduce cyclicality in flows, as investors come into equity in a phased manner with much longer-term horizons compared to lump sum investments.

The third factor is the aggressive selling of hybrids by the industry rather than thematic based equity funds. Hybrids are less volatile and therefore can offer a smoother investment journey through corrections - which again contributes to lower cyclicality of flows.

The final factor that we believe is contributing towards the structural shift of savings into equity markets is that post demonetization, the flood of money into the banking system will ensure that deposit rates remain in the mid single digits. A 6-7% deposit interest rate works out to around 5% post tax - which is not a high bar to cross. Equity does not need to deliver the kind of returns it has done in the past 2 decades, to remain competitive. Even if we look at a 10% return on equity investments over the next few years, it's still way ahead of competing investment avenues in a low inflation environment.

WF: How has 2017 shaped up for Sundaram Mutual?

Sunil: 2017 has been a fabulous year for us, like it has been for the industry. In terms of growth in net flows, its been even more astounding. There are a few highlights that have made 2017 an extremely satisfying year for us.

  1. Our SIP book has doubled in 2017

  2. We have crossed the 1.5 million mark in terms of number of customers

  3. Three years ago, we set a strategic target of crossing an overall AuM of Rs.40,000 crores - across mutual funds, PMS, offshore etc. This year, we have achieved this milestone and are now going back to the drawing board to articulate a fresh strategic goal

  4. We added value to the industry by innovating and repositioning an existing product into a Rural India thematic fund - which offers investors the opportunity to capture the upsides from rural India coming from two successive good monsoons and the Government's sharp focus on enhancing farm income. It is a good example of the right product at the right time.

  5. Our active retail distributor count went up by 40% in 2017. We now have over 7,000 active distributors.

  6. In addition to our continuing focus on retail, we have also been able to expand our footprint in the wealth segment. Our PMS business continues to grow rapidly - in addition to this, we have also launched an AIF business, we had two successful AIF product launches and have mobilized over Rs.1,000 crores in AIF assets.

  7. We have been able to drive performance in the large cap space - and now have our Select Focus fund among the top 3 in the large cap funds league table on a 1 year basis and at 10th position on a 2 year performance basis. As you know, we have been getting very healthy flows over the years in our mid and small cap funds but lagged behind in the large caps space. Now, with our performance speaking for itself, we look forward to healthy flows in the large pool of large cap inflows.

WF: What are your plans at Sundaram Mutual for 2018? How has SEBI's scheme consolidation initiative impacted your fund suite? What are your product plans consequent to the new categorization?

Sunil: Our focus on growing retail and making inroads in the wealth space will continue. One set of plans for 2018 however is a direct fall out of us being one of the few beneficiaries of SEBI's product rationalization initiative. Other than a couple of debt funds with small AuMs, we really did not have to merge or restructure any of our equity and debt products - on the contrary, we are well placed to seek SEBI approval now for 2 open ended funds and launch them in 2018.

In the hybrids space, we have our Balanced Fund, but we did not have an Equity Savings Fund. We plan to launch our equity savings fund - 33% allocation each in equity, debt and arbitrage - and participate meaningfully in the flows that are going into this growing category.

Next, we plan to launch a diversified large cap fund. Our Select Focus will be positioned in the Focused Equity category - not more than 30 stocks. That gives us an option on the back of Select Focus' performance to go out into the market and raise assets in an open ended diversified large cap fund.

If you look at it, our growth in 2017 has happened despite us not having a strong presence in two of the largest selling categories - low and medium risk hybrids and equity large cap. In 2018, with products in both these categories, we aim to participate more meaningfully in two of the most popular fund categories.

The second initiative for 2018 is creation of a specialist unit within our company to exclusively focus on the wealth segment and on PMS and AIF offerings for this segment.

The third area of focus will be credit funds in the debt space. Historically, we never played credit. Last year, we hired a credit specialist and repositioned one of our funds to become a credit fund that focuses on the shorter end - the 2 year segment. The fund is gaining traction and has crossed Rs.500 crAuM in 2017. In 2018, we will be putting in sales focus on this fund to make inroads into the credit funds space. We will continue to maintain the 2 year duration strategy for two reasons - one is our view on debt markets for 2018 as we have already discussed and second is that we want to first establish sound track record with shorter duration credit strategies before venturing into the higher risk space of longer duration credit.

WF: All seems quiet on the regulatory front right now vis-Ã -vis the separation of distribution from advice. Looking ahead, how do you see this move panning out and how should MFDs prepare for potential segregation between advice and distribution?

Sunil: I think this is the lull before the storm. From our interactions with the regulator, we believe they are directionally heading clearly towards separation of distribution and advice although their immediate priorities seem to be on product rationalization and related matters. They haven't taken their eyes off the intermediation piece and clearly their message to intermediaries is they need to clearly make up their minds and state whether they are working for investors or manufacturers. So there are really 3 options for every intermediary - you can either be an MFD or an RIA or you can create an organization with appropriate Chinese walls that separate out distribution and advisory functions as required by SEBI regulations.

For IFAs to think about creating either pure RIA models or hybrid structures, there is a need to think about collaborating with like minded professionals. Advisory fees will not match product based commissions - which means when top line reduces, you need to think of consolidating to prune down costs and boost efficiencies so that you can still run viable businesses on lower gross margins.

We have to see what the new regulations stipulate as the boundaries of recommendations that MFDs can make to their clients. The fact is that today an MFD's client looks to the distributor as his advisor - not just as a seller of mutual funds. Maintaining that relationship, making those recommendations that matter so much to clients - that could be a challenge in the MFD model. Will there be a prohibition on scheme related recommendations only while allowing asset allocation related advice and guidance for MFDs? Will goal based SIP plans be construed as advice or will it be a permitted activity for MFDs? Will MFDs be allowed to offer guidance - especially during periods of market volatility - and help investors stay invested through market and economic cycles? These are some issues that will hopefully get clarified when SEBI comes out with its final regulations on distribution vs advice.

WF: What are some of the key tech trends you are seeing across the industry - client servicing, sales and distribution - which you think will have a material bearing on how our industry shapes up in the coming years?

Sunil: Digital is at a take off stage for our industry. We are making a serious investment in 2018 in enhancing our digital capabilities. In 2017, we made a big investment in digitizing our internal processes - especially our sales processes. We have invested in a GPS enabled sales call optimizing software - so if my RM is in a particular locality in a city, the software will inform him that a couple of streets away there's another distributor who can be contacted, and his details to enable our RM to make the most of his visit to each locality in the city. We have also tied up with the Franklin Covey organization to enhance our sales management and planning - by categorizing each distributor and planning and executing engagement strategies for each distributor to maximize our opportunity. These efforts of 2017 have digitized our internal processes and have set a strong base for our external digital initiatives in 2018, under a CMO who assumes charge of an expanded marketing role with a large digital component, in January 2018.

I believe Aadhar is a huge digital enabler. It is already being leveraged to simplify customer onboarding - which has historically been one of our industry's weak points. Think next of a situation where consumers can switch across fund houses - just as they have mobile number portability today. Today, every other product that a consumer buys - from groceries to clothes to cars - is digitally enabled. Mutual funds have to be present a digital face to today's new age consumers and investors. By end of 2018, you will see a big jump in digital execution across the industry - digital transactions, digital payments, digital distributor initiated transactions, digital distributor engagement - the whole works.

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