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WF: CY2016 has been a great year for the MF industry in terms of AuM growth as well as new investor acquisition. How do you see business prospects in CY17 and what are likely to be the key business drivers?
Sunil: If I look at the highlights of 2016 which can influence business momentum in 2017, the biggest one is the revival and growth in the industry's SIP book. Our industry's SIP book is growing at around Rs.4000 crores per month, which is an annualized inflow of almost Rs.50,000 crores. Most of these are 3 year SIPs or even longer periods - which means that inflows in 2017 from this source alone can be over 10% of the industry's equity book - which is a very healthy way to begin a year.
The second highlight of 2016 is the resurgence of the IFA. We have seen a lot of IFAs coming back into MF distribution - the number of active IFAs has increased sharply, and they have meaningfully contributed to the huge growth in the SIP base of the industry. This again augurs well for 2017 and beyond.
The third aspect of 2016 is that while in terms of equity inflows, 75% of flows have come into large cap funds, it is the mid and small cap funds that have actually delivered the returns. If this anomaly gets corrected to some extent in 2017, with flows coming in the ration of say 60-40 rather than 75-25, it would be a more balanced situation, and frankly one that plays better into our strengths in the mid and small caps spaces.
With all the volatility we have seen due to domestic and global uncertainties, it is good to see increasing flows into SIPs, because SIPs can really harness this volatility very well and deliver superior long term returns. So, what we should see in 2017 is continued momentum in SIPs and a bit of a tilt in inflows in favour of mid and small cap funds - both of which will serve investors very well over the long term.
I am very optimistic about inflows in 2017. We should keep in mind that the beneficial impact of the Pay Commission increases haven't really come in, as demonetization put a temporary freeze. Going forward, we should see increased SIPs from Government employees, as the situation normalizes.
Demonetization itself has two beneficial impacts for inflows into our industry. One is that interest rates are heading down after the deluge of liquidity into the banking system - which means the hurdle rate for our industry has been lowered. Second is the quantum of funds that have come in from the cash economy to the banking system. If our industry targets the same 15% share that it currently enjoys (MF industry retail AuM as a %age of retail bank deposits), we should get 15% of Rs.14 lakh crores, which is an incremental Rs. 2 lakh crores into the industry. That's a huge incremental inflow we are talking about, from retail investors.
WF: How would you rate Sundaram Mutual's performance in CY16? What were the big hits, what were some of the misses?
Sunil: One of our biggest hits in 2016 is that our Midcap fund - which has always been a long term wealth creator - has come back into top quartile this year, which augurs well for inflows going forward. The second one is that a product that was a sleeper product for years - our Rural India Fund - came sharply into focus this year, as the market's attention turned towards the rural story, and we have one of the few pure plays on the Indian rural story in the market.
In a year when its benchmark (BSE 500) delivered a 6% return, this fund has delivered a 22% return. What's more heartening - and I have to thank our distributors for this as they caught onto the theme and the fund early on - the fund has quadrupled in size, making good money for a lot of investors in 2016, with the potential to make healthy returns going forward as well, as the rural story plays out over the next few years.
In terms of misses, I would go back to what I mentioned last year - our large cap space is still work-in-progress. We have to create a healthier performance track record to merit better inflows. We have hired a specialist for our large cap portfolios - he has joined us on VijayDashami this year and we think we now have the right mix of specialist talent and senior management attention to this space, to deliver robust performance and attract our fair share of flows.
WF: What are your business plans for CY17 to enhance momentum and gain market share?
Sunil: As you know, our core strengths lie in managing mid and small cap funds. In recent years, we have also built up a strong niche for ourselves in the micro caps space, with over Rs.1500 crores of AuM across a series of 11 closed ended funds dedicated to this space. Our firm conviction is that as the economy comes out of the demonetization lull and gets back into the up-cycle, the biggest beneficiaries of the cycle will be mid, small and micro cap stocks, whose earnings will grow faster than market due to the impact of higher operating and financial leverage. For investors, long term wealth creation prospects clearly are better in the mid, small and micro cap spaces, and our focus on this segment will continue to remain strong. While we will work on enhancing our large cap presence, our focus will continue in our traditional areas of strength, which we believe will better value to investors over the cycle.
Two emerging segments that we believe will become increasingly relevant in the next 2-3 years are the RIA segment and the PF segment. PFs are institutional investors and very cost sensitive, which means their interest will continue to be largely in the passive space. Likewise, we expect RIAs to focus increasingly on passive funds, given their focus on demonstrating lower costs as one of the levers to justify fees.
While we have a presence in the index funds space, we are augmenting it with a suite of smart beta funds. Our first offering - which we launched this week - is an equally weighted Nifty 100 index fund. More smart beta products are in the pipeline and we would like to create a strong position for ourselves in this emerging segment. While this segment may not deliver meaningful results in 2017, we expect it longer term to become a vibrant segment - especially low cost smart beta products that add a dash of alpha while controlling costs.
The third focus area for 2017 is our rapidly growing PMS business. 3 years ago, it was less than Rs.300 crores, now it has grown to over Rs.1500 crores. To supplement the PMS business, for distributors and investors who are in that higher risk spectrum, we will be launching soon our AIF products (both category II and III).
So, as you can see, our efforts in 2017 will be to significantly broadbase our business, while continuing to build on our core competence in mid and small caps. Large caps, PMS, AIF, smart beta - we aim to cater to all segments of investors, distributors, advisors and institutions.
WF: A lot of effort is being put into ease of account opening (e-KYC) and enhancing market access (Aadhaar based investments upto Rs.50,000). How do you see these initiatives impacting business in CY17 and in what ways should distributors gear up to make the most of these initiatives?
Sunil: I am honestly still a sceptic on this as I am not sure that ease of doing business is the fundamental issue that is coming in the way of enhanced retail penetration. I think as an industry we still have our work cut out in getting retail savers to be more comfortable first with capital markets and then with mutual funds. Ease of opening an account and ease of transacting come after the intention to do so has first been firmly established. These initiatives are good no doubt, but in the near term, they will serve as cost reduction exercises more than market penetration initiatives. Are these going to become key business drivers in 2017? Unlikely in my view. From a longer term perspective, I think as RIA gets embraced, particularly by large players who think large volumes, they might really drive these initiatives as any cost reductions would be embraced by them, given their need to demonstrate value at multiple levels to earn their fees.
WF: There is a lot of uncertainty among distributors, on account of the discussion paper on proposed changes in RIA regulations coming close on the heels of enhanced disclosure requirements. How do you see intermediation models evolving realistically in our country over the next 3 years, in light of the regulatory direction on one hand and the urgent need for distribution expansion on the other?
Sunil: My honest opinion is that nothing much will change at the ground level. Expecting a large cross section of investors to pay a fee that comes even close to the current commission structures appears a very tall ask. Large distributors who have accumulated sizeable AuMs on high trail commissions, will be relatively more inclined to consider the RIA model as their costs are underwritten by existing trail, which will continue. However, it is reasonable to expect all distributors to look for ways in which they can operate in both segments - MFD and RIA. Whether this is through subsidiaries for those who can set up such structures or through informal arrangements for those who cannot, I think there will be a keenness to explore such alternatives, to ensure viability of the business.
One thing is very clear to me: it is the distributor who earns commission that is embedded in the product cost, who is going to expand the market and reach retail savers who are not yet aware of or comfortable with mutual funds. Expecting this service to be rendered by an advisor who will charge a fee from these first time investors, is unrealistic. Cost of expansion is always paid by the customer - and this has always been done by embedding this cost within the product cost.
Yes, when distributors are constrained from offering advice, they will have to make alterations in their processes. They will have to adopt more of a supermarket approach rather than active recommendations on specific products. I suspect most distributors will still choose this over becoming RIAs.
Our distributors have managed change admirably over the last 8 years and have emerged stronger each time. I think they will manage these challenges too, and continue building stronger retail businesses by reaching out to more and more savers. I believe distribution will continue to mobilize at least 80% of flows into the industry in the foreseeable future.
WF: For markets, near term uncertainties abound locally as well as globally: demonetization, GST implementation, Trump, US Fed, Italian banks, French elections - the list is endless. If global liquidity flows into emerging markets continue tapering off as they have in recent weeks, could there be a significant risk to our expectations of healthy domestic equity market performance over the next 2-3 years?
Sunil: All the risk factors or imponderables you mention are all factors that induce volatility in the market - but none that materially alters the fundamentals of the Indian market. Ultimately, markets are a slave to earnings growth. If you look at the India story pre-demonetization, the two near term stimuli were the Pay Commission payouts which deliver more money into the hands of Government employees and bountiful rains which augur well for rural demand.
Beyond these short term stimuli, the structural story is that in the next decade, out of 500 million people in the world who will join the work force, 125 million will be in India alone. This set, together with the crop of existing unemployed, will drive economic policy in India as they have the ability to alter the political landscape with their votes. That's what is driving Make in India, that's what is driving GST. GST is not so much a revenue simplification initiative - rather it is a huge tool in the hands of the Central Government to woo large FDI, with incentives and waivers that can be handed out centrally under the GST structure, especially for re-exporters. India will be well on its way to become a global manufacturing hub, once GST is implemented.
When GDP grows with this structural impetus, the biggest beneficiaries will normally be in the mid and small cap spaces. Most of the volatility you talk about will be felt in more globally owned stocks which are in the large caps space, while the next level of companies are more domestically owned. I believe the current bout of volatility is a great opportunity for retail investors to accumulate equity funds when market valuations are reasonable. SIPs benefit from volatility and therefore, I am confident that we will see investors getting healthy investment outcomes after their 3-5 year SIPs, which will hopefully build further equity conviction in them.
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