Tax blow? Brokers keep faith in AMCs

In the face of tax blow, brokerages remain sanguine about the prospects of asset management companies (AMCs).

A sharp correction in the shares of AMCs over the past three months factors in most of the negatives and turned valuations attractive, observe analysts.

In its latest report, Kotak Institutional Equities (KIE) has upgraded HDFC AMC to ‘add’ (from ‘reduce’) and reprised ‘add’ and ‘buy’ ratings on the rest of the listed AMCs — Nippon, UTI, and Aditya Birla Sun Life.

JM Financial, too, has a ‘buy’ rating on most AMCs.

The brokerage says the mutual fund (MF) industry may register a 5 per cent drop in assets under management (AUM) under debt schemes in the next financial year (2023-24, or FY24), against earlier expectations of 12 per cent growth in AUM.

It expects investors to divert money into other fixed-income investment options after debt MFs were stripped of the long-term capital gains (LTCG) benefits.

In another note, Prabhudas Lilladher has said it sees minimal impact on the bottom line of AMCs, even if debt inflows fall 20 per cent.

AMC shares have corrected 3.5 per cent to 12 per cent in the last two trading sessions and are down 20-30 per cent in three months.

This has led to significant improvement in their valuations.

Analysts say AMC shares now trade at price-to-earnings multiples of 15-22x their estimated earnings for 2024-25.

The drop in shares of AMCs in recent months is being attributed to fears of regulatory tightening.

The Securities and Exchange Board of India (Sebi) may rationalise expenses charged by AMCs to bring down the costs for investors.

Any such move will bring down the margins of AMCs as well.

The tax blow announced in the Finance Bill for debt funds has further soured investor sentiment.

Brokerages see limited impact of the tax change on AMC revenue.

They expect a section of the flows, which debt funds stand to lose, to find its way into hybrid funds like balanced advantage and equity savings schemes that are comparatively safer than equity funds but taxed as equity schemes (leading to LTCG benefits to investors).

“Based on discussions with AMCs, fund houses might gain from these regulations as debt money may move to hybrid funds (wherein a higher total expense ratio, or TER, is charged),” said JM Financial in a note.

Additionally, the tax change affects only select debt schemes since funds like liquid, overnight, and money market are used for parking money for the short haul and their investors never really profit from LTCG.

Of the industry’s total debt AUM of Rs 13.4 trillion, Rs 8.6 trillion, or 62 per cent of total debt AUM, was in cash and shorter-duration debt schemes in February.

On TER rationalisation, KIE has done an analysis to study its impact on the earnings of AMCs in FY24.

The brokerage has illustrated three different scenarios of severe, moderate, and benign TER cuts in the study and found the earnings declining by as much as 79 per cent to as low as 6 per cent.

In the severe scenario, the brokerage assumes Sebi asking fund houses to bring the goods and services tax (GST) on management fees and trading costs and lower their TER.

In the moderate scenario, it does not consider lowering TER.

In the benign scenario, it assumes only the trading cost to be brought under TER.

The regulator has undertaken an extensive study of the expenses charged by AMCs.

Reports suggest that Sebi may ask fund houses to lower their fees to include costs like GST on management fees and transaction costs incurred while buying and selling stocks within TER.

Investment advisors say they prefer unembellished debt and equity schemes over hybrid ones for designing client portfolios, but the change in taxation has forced a rethink.

“We have not been suggesting hybrid funds. Considering the situation nowadays, we may have to start looking at them,” says Suresh Sadagopan, founder, Ladder7 Wealth Planners.