Case Analysis - 3

Indian Institute of Management Bangalore
Sundaram Finance Ltd.
By
Prof. Rishikesha T. Krishnan

Corporate Strategy & Policy Area
This case has been written by Prof. Rishikesha T. Krishnan with assistance from Dwarakaprasad Chakravarty, PGP, Class of 1999 based on publicly available information, with financial assistance from the Centre for Development of Cases and Teaching Aids, IIM Bangalore.
Case written by Prof. Rishikesha T. Krishnan, IIM Bangalore 2001 Indian Institute of Management Bangalore
Despite being the largest non-banking finance company (NBFC) in India (in terms of asset base), Sundaram Finance Ltd. (SFL) was slow to take any new initiatives in the liberalised economic environment of India in the early 1990s. While recent entrants to the financial services industry had made visible and aggressive forays into a variety of fund-based and non fund-based activities, SFL continued to stick to its conventional hirepurchase business and concentrated mainly on truck finance. By 1995, SFL had made a small beginning in the securities business and as a merchant banker through newly created subsidiaries. In 1996, some analysts were concerned about the reported move of SFL to start a mutual fund as the net asset value of most mutual funds was below par. They were worried that entry into the mutual fund business could dilute the image of reliability and safety, which SFL had built up over the preceding 42 years. Other analysts believed that this could be the first major move towards transformation of SFL from a strong niche player to a financial powerhouse.
Non Banking Finance Companies (NBFCs)

The Indian financial sector has two broad segments organised and unorganised. The organised segment includes commercial banks, development finance institutions,
insurance companies, non-banking finance companies and mutual funds.
Non-formal sources of finance existed in India before commercial banks emerged. The moneylender, the chit fund, and mutual credit societies were part of the financial scene
long before the modern banks.
Most entrepreneurs found it easier to raise funds from
non-banks rather than from banks. For instance, the rise of Indias film industry would have been impossible but for non-bank finance.1 From a mere Rs. 3,161 crores in 1984, aggregate NBFC deposits stood at somewhere between Rs. 10,000 and 15,000 crores by 1994. There were over 40,000 NBFCs in India in 1994.
Except for issuing chequebooks and handling small cash transactions, NBFCs perform similar functions as banks. NBFCs have progressively been subject to reserve requirements on almost the same lines as banks. The Reserve Bank of India has been authorised to determine the policy and issue directives from time to time to the NBFCs regarding income recognition, accounting standards, asset classification, provision for non-performing assets and capital adequacy.
NBFCs mobilise funds from depositors just as commercial banks do. As the risk associated with NBFC deposits is greater than with bank deposits, depositors receive higher rates of return on their funds. NBFCs disperse these funds through:
Hire Purchase: These are schemes for financing the acquisition of commercial and private vehicles (generally trucks and cars), as well as plant and machinery. The loans are secured by the purchased asset.
Loan Schemes: These schemes finance industrial projects and real estate acquisitions.
one crore=ten million 3
Investment Schemes: The funds mobilised are used to purchase corporate and government securities and other money market instruments.
Equipment Leasing: These schemes finance leases of industrial equipment (plant and machinery)
Nidhis and Chit Funds: Here, the mobilised funds are loaned or distributed among the depositors themselves in a variety of ways.
Exhibit 1 shows the Category-wise distribution of NBFC schemes with net owned funds over Rs. 5 million (as of September 30, 1995)
The TVS Group

SFL was promoted by T.S. Santhanam, the son of T.V. Sundaram Iyengar, one of the early industrialists of south India. From Iyengars early ventures in the field of road and bus transport and a dealership for General Motors in the early twentieth century emerged the TVS group as a diversified business family with interests in a whole range of automobile and transport-related businesses. While SFL itself was founded by Santhanam in 1954, the major growth of the group took place in the 1960s.
In the 1960s, the TVS group set up a string of automobile parts manufacturing units, largely with foreign collaboration. Among the companies that were promoted were Lucas-TVS (auto-electric systems), Brakes India (brakes), Sundaram Clayton (brake-
linings), Sundaram Fasteners (fasteners), Wheels India (wheels) and Sundaram Abex (brake linings). These companies were founded by Santhanam and his three brothers, T.S. Krishna, T.S. Rajam and T.S. Srinivasan. Santhanam is credited with having arranged the finances for these new ventures.
By the early 1990s, the companies of the TVS group were being run largely by the third generation of the TVS family. Management control of these companies had been divided among the different branches of the family though ownership remained diffused as most of the companies had been promoted by the group holding company, TVS & Sons Ltd. However, SFL was promoted by Santhanam and his associates, and his branch of the family was in total control of the company.
As of 1992, the TVS group companies had a combined sales turnover of approximately Rs. 2,000 crores, making them one of the largest industrial groups in India. However, their growth had not kept pace with some of the other industrial families who were their contemporaries or with new entrants like the Ambanis of Reliance or the Ruias of the Essar group. The TVS groups image was one of solidity and conservatism with a reputation for quality.
SFL - the beginnings

T.S. Santhanam had worked in the family business since 1930. He was responsible for the successful creation and operation of the countrys most successful insurance
company, the Madras Motor and General Insurance Company (MMGIC) which was subsequently nationalised by the government of India.
To help small transport operators who were being exploited by moneylenders, he set up SFL as a subsidiary of MMGIC in 1954. In the early days, bank finance was not available for hire purchase and it was only in 1956 after the amendment of the State Bank of India Act that companies like SFL could have access to bank funds against receivables. Even then, SFL was one of the few companies to have access to this facility.
SFL started on a small capital base of Rs.0.02 crores and by end-1955 had stock-on hire of Rs.0.57 crores. SFL earned a profit of Rs.0.01 crores in that year and declared a maiden dividend of 5%. At the end of a decade, in 1965, SFL had reserves of Rs.0.31 crores, stock-on-hire of Rs.5.58 crores and deposits on hand were Rs. 1.73 crores. For a summary of SFLs financial performance over the years since inception, see Exhibit 2.
Stock -on-hire is calculated as agreement value of the assets financed through hire purchase less the payments received
SFL - 1970s and beyond

SFL had its one and only public issue of capital in 1972 in the form of an offer of sale by the promoters of 100,000 shares (representing 10% of the equity) at a price of Rs. 13.50 per share. This enabled the public listing of the company and SFL became the first NBFC listed on the Madras Stock Exchange.
SFL continued to grow slowly but steadily during the 1970s. The industrial climate was weak following the socialist policies of the then government of India. The transportation sector went through a particularly stressful time in the wake of the nationalisation of bus routes in 1970. There were persistent rumours that the road transport industry would also be nationalised and these had a negative impact on the demand for trucks and hence the demand for truck finance. During this phase, stresses also appeared within the TVS family and the first steps to divide managerial control amongst different members of the family were initiated.
In spite of these problems, by 1975, reserves had risen to Rs.1.08 crores, stock-on-hire to Rs.21.40 crores and deposits to 11.76 crores. SFL entered the 1980s with reserves of Rs.2.26 crores and stock-on-hire of Rs.47.14 crores. Deposits had risen to Rs.26.28 crores and net profit for the year was 0.91 crores in 1980.
SFLs growth was much faster and smoother during the 1980s and 1990s during which India managed to break out of the Hindu rate of growth and achieve higher levels of economic development. Reflecting this, by 1995-96, SFLs reserves had swelled to
Rs.204.31 crores, stock-on-hire to Rs.1209.64 crores and deposits to Rs.550.44 crores. Net profit for the year was Rs. 64.92 crores.
Diversification into Leasing

Till the early 1980s, SFLs principal business was truck finance. The opening up of the leasing business provided a new opportunity for growth and SFL decided to enter the leasing business in 1981. To focus more specifically on the leasing business, SFL created a subsidiary company, India Equipment Leasing Ltd. in 1983 with equity participation from the International Finance Corporation, an associate of the World Bank.
SFL subsequently entered the leasing business on its own as well. By 1995 about onefourth of the companys receivables were on account of plant and equipment leasing and the remaining three-fourths in Hire Purchase receivables. While some industry sources believed that SFL was a player in the leasing business only for the tax shelter that leasing offered, this was denied by SFLs top management: We dont believe in tax shelters T.S. Santhanam, Founder and Chairman, SFL.
Leasing is a profit centre for us. It is a different source of operational funding for the industry. How can we ignore it? G.K. Raman, Managing Director, SFL.
SFLs Equity Base & Dividend Policy
From a small equity base of Rs.200,000 in 1954, SFLs equity base had risen to Rs.24 crores in 1996. It is believed to be the only NBFC never to have diluted its equity through public or rights issues. SFL has rewarded its investors with continued dividends and bonuses. Bonus issues account for 96.7% of its capital. An investor who bought SFLs share in 1972 for Rs.13.50 earned a return of 840% over the next 24 years. SFL has maintained a fairly consistent and conservative policy regarding dividends. Dividend payout increased five-fold between 1987-88 and 1994-95 while profit after tax increased more than ten times during the same period.
A snapshot of SFLs operations

As of 1996, truck financing contributes about 73% to SFLs disbursements, automobile financing takes up 14% and leasing the remaining 13%. These activities are funded through internal accruals, bank borrowings and from the market by way of fixed deposits. Fixed deposits from individual investors constitute around 50% of SFLs borrowings. The total cost of funds works out to around 20% including about 3% towards overheads and the cost of procuring funds. Typically, truck financing costs 26-28% per annum. Therefore, SFL enjoys a spread of 6 -8%. See Exhibits 3 and 4 for SFLs balance sheet and income statement for the financial years 1995 and 1996.
Credit Rating
SFLs fixed deposit programme enjoyed a credit-rating of FAAA from credit rating agency CRISIL (April, 1996), indicating the highest degree of safety regarding timely payment of interest and principal. CRISIL attributed this rating inter alia to
(i) (ii)
A strong and committed management team. Highly efficient operating systems, including credit appraisal and credit
monitoring. (iii) A low likelihood of a tenor mismatch between the sources and deployment of funds due to high renewal rate of fixed deposits. (iv) Strong financial flexibility arising from its investments in shares and debentures of corporates, its bill discounting portfolio and real estate owned by the company. (v) Conservative accounting policies.
Top Ranked NBFC

According to a study conducted by a research agency in 1996, SFL emerged as the top NBFC. This ranking was based on the hybrid average weighted score methodology which was believed to be a rigorous means of determining the aggregate financial, operational and market strength of an NBFC. The top 10 companies in descending order of ranking as per this study were Sundaram Finance, Reliance Capital, Kotak Mahindra, Tata
Firms in need of working capital may approach banks and NBFCs with bills of receivables. The bank or NBFC may then provide a discounted amount, which is equivalent to the present value o f the receivable (depending on the risk involved). This process is known as bill discounting
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Finance, Lloyds Finance, CRB Capital Markets, SRF Finance, Cholamandalam Investment and Finance, Anagram Finance and Ashok Leyland Finance.
Reasons for the success of SFL2

Sharp focus, commitment to values of fairness, honesty and integrity, and very high levels of customer service are some of the reasons for SFLs success. See Box below for SFLs corporate objectives and corporate philosophy.
OBJECTIVES To channelise household savings To assist small road transport operators To provide lease finance to industries (from 1981)
CORPORATE PHILOSOPHY Truth and fairness guide the management of finance. Customer satisfaction through excellent service and reliability. Prudence and conservatism in financing operations. Truth honesty and efficiency in all dealings. Professional management with highest standards of integrity. Full compliance with all laws and regulations.
Source: http://www.sundaramfinance.com
Enabling the growth of SFL has been the loyal support of a growing base of small depositors. While most of the depositors were originally from the south Indian state of Tamil Nadu where the company was founded, by 1996, the depositor base had become more diversified. While offering interest rates only slightly above the rates offered by public sector banks, SFL has managed to build a strong and loyal customer base.
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This has been possible due to the image of trust and integrity enjoyed by the TVS group to which SFL belongs, but also due to the efforts by the company to build customer support. Its customer-friendliness is legendary. Some years ago when the staff at the State Bank of India where many of its depositors bank, was preparing to go on strike, the company predated and despatched interest warrants about a fortnight ahead of their due date to prevent any inconvenience to its depositors. In another often-quoted instance, many years ago when a middle-aged widow complained that she would have to bear costly legal expenses to be able to withdraw her l te husbands deposit with the company, a the management decided to not only foot her bill but to henceforth provide all legal documentation and help for transfer of an account of a late depositor to his or her heirs. The company is also known to automatically offer the option of renewing existing deposits at higher interest rates when sudden and sharp increases in deposit rates take place.
Everyone has discovered how important customer satisfaction is in recent years. We started on the basis that customers are our friends. We are not moneylenders. We stand by (our customers) during good times and bad times; and they will stand by us when we need them. T.S. Santhanam, Founder and Chairman SFL3
Helping the company provide good customer service was the culture of the company. The companys top management believed that shareholders would be benefited only if other
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stakeholders of the company are benefited at the same time. The TVS group, and SFL in particular, were known to be model employers and this was reflected in the low turnover of employees from the company.
SFL has to take very few steps to actively market its deposit schemes. In fact, for many years, SFL was the only NBFC to refuse to pay brokerage which was actually a euphemism for an upfront commission for deposit mobilisation. One estimate suggests that as many as 90% of deposits in SFL are unsolicited and get automatically renewed. The renewal rate exceeds 80% even for short one-year deposits. The average size of deposits is Rs.10,000 and the number of depositors exceeds 420,000. Even in times of recession and falling interest rates, SFL has had little difficulty in raising deposits. This is reflected in the net accretion of deposits exceeding Rs.100 crores per annum in recent years.
Equally important to SFLs success is its choice of targets for its lending activities. While its original choice of small truck operators was driven by the fact that these operators were being exploited by moneylenders and did not have other sources of finance, over the years SFL has found that this is an ideal group to lend to. Unlike big fleet operators who often enjoy political patronage and are difficult to control, small operators who own one or two vehicles each have proved to be reliable in meeting their debt obligations. The key is to evaluate the operators creditworthiness effectively. The company has managed to hone its expertise in this area over the many years of its operation and keeps a close tab on about 38,000 individual loan accounts of an average size of Rs.2,40,000 which
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support a vehicle population of over 40,000. SFL has managed to maintain a high loan recovery rate of 97.97%. As of March 31, 1995, overdues amounted to only 1.2% of stock-on-hire, the lowest in the industry and non-performing assets were a reasonable 0.7% of all business assets.
To avoid bad debts, SFL takes special steps to know its customers. The backbone of this is its personalised intelligence network. It has a network of 80 branches (1995), a lending operations staff of 500 people and a field collection staff of about 250. The original branch network covering the southern states of India was expanded into strategic locations in the north and west from around 1985. Reflecting this expansion, the number of branches grew from 36 in 1985 to 65 in 1990, and to 80 in 1995.
Each client is contacted, on the average, once in ten days and a personal relationship is established with company staff. There is one field staff for every 300-400 clients. Many of the companys branch managers are important social figures and opinion leaders in their communities. Their local standing enables them to continuously monitor the financial status of each borrower - his ability as well as willingness to pay. This network is key to ensuring effective credit rating of thousands of small, dispersed and unorganised truck operators, many of whom do not even maintain proper books of account. This ultimately leads to timely recoveries, early warning and control of problem accounts and consistently high asset quality over long periods of time.
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This is a specialised field. We know our customers personally. Our credit appraisals are based sometimes on knowing two or three generations of a customers family and not on ratings and bank guarantees G.K. Raman, Managing Director, SFL. 4
The average tenure of deposits and renewals is two years which matches the average hire purchase lending period of 2.5 years quite well thus avoiding a serious mismatch between deposits and receivables.
Competition
In seeking deposits from the investing public, SFL competed with a whole range of alternate instruments offered by the government, banks, financial institutions, mutual funds, and other NBFC's apart from unincorporated finance companies, mutual benefit funds and local financiers in the unorganised sector. Exhibit 5 depicts distribution of household savings among various financial instruments.
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Government securities, banks and financial institutions:
While the interest rates offered by government securities were much lower, they offered the safety of the sovereign guarantee. Government securities were however considered to be highly illiquid. Deposit schemes of banks (most of which were wholly owned by the government of India) and government owned or controlled financial institutions offered higher interest rates than government securities. While public sector banks had limited retailing strength, in the 1990s the financial institutions were getting more aggressive in the retail market with a network of agents and sub-agents and extensive advertising in the print media and television. Household bank deposits were estimated at Rs. 35,284 crores as of 1995-96.
Other NBFCs:
In 1996, there were an estimated 40,000 NBFC's in India, though only 4,000 of these were believed t be active. These NBFC's had been created in two waves the first one o of leasing companies in the early 1980s, and the second one prompted by the ease in accessing the equity markets in the early 1990s. The NBFCs depended on equity capital, finance from banks and deposits from investors to fund their activities, which included bill discounting, leasing, hire-purchase and merchant and investment banking. Raising money from banks was difficult because the banks felt that the NBFCs were competitors, there were RBI curbs on bank lending to NBFCs and, in many cases, the banks felt it imprudent to lend to NBFCs. Several large and aggressive NBFCs
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competed with SFL in the fixed deposit market. A profile of two leading NBFCs Kotak Mahindra Finance Ltd. and Cholamandalam Investment and Finance Company Ltd. is given below. Exhibit 6 compares SFLs financial performance with these two NBFCs on the basis of some of the parameters used by CRISIL for credit rating.
Kotak Mahindra Finance Ltd (KMFL).: Fixed Deposit Programme Rating FAAA (CRISIL) KMF was formed in 1985 through a partnership between a young management graduate, Uday Kotak, and the Mahindra group with a capital of Rs. 3 million. Its initial strategy was to capitalise on the imperfections of the Indian capital market and to enter relatively under-regulated areas like bill discounting. KMFL later diversified into leasing and lease syndication of big-ticket leases. KMFL entered consumer finance through the automobile finance market around 1990. In 1994-95, KMFL had a gross income of Rs. 246 crores and a net profit of Rs. 64 crores. By mid-1995, KMFL had announced its decision to hive off its three major businesses investment banking, consumer finance and asset finance as separate companies, to enter into joint ventures wherever necessary, and to enter new areas like insurance, information services and mutual funds.
Cholamandalam Investment and Finance Company Ltd.: Fixed Deposit Programme Rating FAAA (CRISIL) Cholamandalam was promoted in 1978 by the Madras based Murugappa Group. The Murugappa Group had a successful track record of managing medium sized companies in diverse fields, and a conservative management style. Cholamandalam commenced
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leasing of plant and machinery in 1979 and subsequently ventured into hire purchase financing of plant and machinery in 1982, and bills discounting in 1987. The company grew fast between 1992 and 1995, with funds deployed registering a compounded annual growth rate of 49% to reach Rs. 330 crores by June 1995. Cholamandalams main line of business was hire purchase financing with the accent shifting to financing cars, LCVs and HCVs. However, plant and machinery continued to enjoy a sizeable chunk of the asset portfolio. Cholamandalam also does bill discounting with the average deployment of funds at about Rs. 40 crores.
The Unorganised (& unregulated) sector:
This sector is vast and no accurate estimates exist of its size. It principally consists of proprietorship or partnership firms which offer interest rates as much as 10 per cent more than the NBFCs. They are unregulated and play on the greed of investors. Their avenues for lending are limited and many of these firms collapse after some time leaving investors in the lurch. They nevertheless continue to attract interest among depositors and use hoardings to announce their products and on-the-spot incentives to attract investors.
Mutual funds:
Mutual Funds (MFs) are financial intermediaries which pool the savings of numerous individuals and invest the money raised in a diversified portfolio of securities, including equity, bonds, debentures and other instruments, thus spreading and reducing risk. Individual investors receive units/shares of the MF for the amount they invest. Small
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investors are unable to buy blue chip shares, which trade at high prices. However, if these investors purchase units/shares (at say Rs. 10 per unit) of an MF which acquires these blue chip shares, they have an indirect equity stake in the blue chip firms. Also the small investor rarely has the time or the knowledge to analyse the prospects of corporates, unlike dedicated and qualified analysts at MFs. Hence MFs seem to be an easy and safe route for the small investor to enter the stock market.
Mutual Funds differ from banks and banking companies in that banks provide transaction services i.e. monetary liabilities which facilitate the exchange of goods and services by transforming short term liabilities (deposits) into long term assets (loans). The MFs do not have fixed liabilities to pay, as interest or dividend on the holdings of the investors is not guaranteed until expressly committed as such. They simply manage portfolios whose values may increase or decrease and dividend is paid only if a surplus of income is made. These funds have different schemes with growth, income or balanced funds as their objectives. Exhibit 7 provides a description of several Mutual Fund Schemes.
The Mutual Funds Diversification Decision

Unlike many other NBFCs, SFL did not move aggressively into new areas immediately after the historic announcement of economic policy changes by the Indian government in 1991 and the gradual unfreezing of the financial services sector in the following year. Instead it opted to move slowly, testing the waters with gradual investments.
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Sundaram Finance Services Ltd. was formed in 1991 to undertake merchant banking and advisory services apart from other NBFC activities like bill discounting, leasing and hire purchase. While the initial focus was on the former, by 1996 the latter had begun to dominate. The company earned a gross income of Rs. 11.77 crores in 1995-96 and a Profit after tax of Rs. 2.32 crores. The gross income consisted largely of income on bills purchased (Rs. 7.55 crores) and lease income (Rs. 2.79 crores) while management and other services contributed just Rs. 0.38 crores to the gross income figure.
Another subsidiary, Sundaram Finance Securities Ltd., was established in 1994-95 to undertake stockbroking activities. In 1995-96, this company had a marginal profit against an operational income of Rs. 0.18 crores.
In the light of these slow moves, analysts were surprised by the 1995 announcement that SFL planned to set up a mutual fund.
Growth of Mutual Funds in India over the previous 10 years

The Indian Mutual Funds Industry recorded a tremendous growth in size with cumulative resources mobilised rising from Rs. 4,564 crores in 1986 to over Rs. 81,000 crores in 1996.
The Indian mutual fund industry began with the formation of Unit Trust of India (UTI) in 1963. The first mutual fund was Unit Scheme '64, which is still the biggest scheme. The UTI introduced several schemes aimed at different sections of people. The public sector
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monolith operated under monopoly conditions and in an over regulated economy till the mid-eighties. In 1987, the commercial banks and the insurance companies were also permitted to launch schemes. Their schemes were received with enthusiasm and more than Rs.6,000 crores were raised in 1988-89. The mutual funds launched by subsidiaries of nationalised banks sold their schemes like any other traditional banking deposit. Assured returns were offered in some schemes and this might have created a perception that mutual funds are as safe as nationalised bank deposits. The boom continued into the nineties with the liberalisation evoking positive response from the investors and acting as an additional catalyst for growth. In 1991-92 mutual funds mobilised a record Rs.14,000 crores.
The industry experienced its first setback after the stock market crash of 1992. The annual gross mobilisations of the Mutual Funds fell to Rs.9,500 crores during the year. At that point the market was further liberalised as foreign institutional investors were permitted portfolio investments. The financial markets once again picked up. In addition, the period also witnessed a tremendous growth in the primary markets with annual mobilisations from equity issues crossing Rs.36,000 crores in 1994-95 (as against Rs.18,100 crores raised in 1992-93). The resource mobilisations by Mutual Funds also continued to remain high with annual gross mobilisation averaging Rs.14,000 crores per annum during the period 1993-95. This phase also saw the entry of several private sector mutual funds. However the crash in the financial markets in October 1994 and the continued prevalence of bearish conditions hit mutual funds. During 1995-96, Mutual Funds resource mobilisations (at around Rs.5,900 crores) were at a six year low.
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In spite of their evolution in developed economies as low-risk, medium return investments, in India most mutual fund schemes are still seen as either substitutes for equity or as substitutes for riskless fixed deposit bonds with regular interest payments. To quote Mr. Basudeb Sen, General Manager (UTI), A Mutual Fund is not a substitute for equity. The investor needs to understand that he/she is taking an average risk, and consequently, the returns are average. Mr. Pratip Kar, Executive Director, SEBI cautions Mutual Funds are not free from risk. Afterall, the money is invested in the stockmarket.5
While in the US, as of 1995, there were over 7,000 Mutual Funds (equivalent to schemes in India) with an aggregate corpus of over US $ 2300 Billion, India had just about 200 schemes with an aggregate corpus of Rs. 75,000 crores (approx. US $ 20 Billion). Exhibit 8 depicts the number and type of Mutual Fund Schemes in India as of October, 1994.
Policy on Private Mutual Fund Formation, Expenses and Remuneration

To spread the equity cult and provide greater stability and depth to the Indian capital market, the government of India permitted the formation of mutual funds by the private sector as part of its economic liberalisation package. While the mutual fund itself was to be set up as a Trust under the Indian Trusts Act, the management of the fund is in the hands of a separate Asset Management Company (AMC) in which the sponsors of the fund have a minimum stake of 40%. The AMC has to be set up with a mandatory share
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capital of Rs. 5 crores. Joint stock companies with a five-year track record of profits were allowed to sponsor mutual funds.
Mutual funds incur both pre-operational and recurring expenses. The former includes the cost of the issue, advertisements, stationery charges, brokerage, commission to agents, stamp duty and other marketing and administrative expenses. These are corpus linked. The SEBI has issued a ceiling of 6% on these expenses. Therefore, if a MF gathers Rs. 100 crore from depositors through an issue, it is entitled to spend Rs. 6 crores on preoperational expenses. Often, the funds of the investors are depleted by the amount of such expenses even prior to the issue.
SEBI permits recurring (annual) expenses which are calculated as a percentage of the weekly net average assets. These expenses have a ceiling of 3%. These could include AMC fund managers' remuneration (which is restricted to 1%), custodial fees and registrar and share transfer agent fees.
The Mutual Fund Industry in 1996

The initial response to the policy initiative deregulating the formation of mutual funds was very positive with almost a hundred applications received within a year. Among these were leading Indian industrial groups like the Tatas, Reliance, Essar and financial companies like KMFL and DSP Financial Consultants. The early interest in mutual funds coincided with the bull run on the Bombay Stock Exchange that continued until the Securities Scam of 1994.
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Mutual funds were becoming increasingly popular among middle class Indian investors in the early 1990s. Some of the trends noted in a study conducted in 19936 are presented in Exhibits 9, 10, 11 and 12. The study found that over 57% of the investors preferred monthly income schemes. It also revealed that over 97 per cent of Mutual Fund investors are individuals while less than 1 per cent comprise corporate and trust investors. However, the corporates and trusts invested over 26 percent of the total funds, while the contribution of individuals was a little over 70 per cent.
By 1995, however, the Indian mutual fund industry hit a bad patch. The Chief Investment Officer of Alliance Capital, one of the leading players, told a business magazine in January 1996 that the only good thing about 1995 is that it is finally over.7 This was an interesting denouement for an industry, which started with bright expectations.
In the first half of 1995-96,
23 schemes of the private mutual funds posted a net loss of Rs. 276 crores on a unit capital of Rs. 2,840 crores;
Only seven of the 23 reported profits; At least six new funds delayed the launch of their schemes; The UTI, the largest fund with 83% of the investible funds in the industry, had a net outflow of Rs. 347 crores during the year;
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Most funds had to cut their targets (e.g. Tata Mutual Fund from Rs. 500 crores to Rs. 100 crores), and the total funds collected by the private mutual funds was Rs. 600 crores against Rs. 900 crores in the previous year.
Investor confidence in mutual funds had declined because of the steady decline in the Net Asset Value (NAV ) of the existing funds. While in 1994 investors tended to compare returns on mutual funds to the easy pickings available through investments in Initial Public Offers of stock, in 1995 it was the turn of debt to outperform mutual funds. About 47% of all household savings in India were in fixed deposits against 7.6% in mutual funds in 1994-95. Exhibits 13 and 14 show the cumulative resources raised by both public and private sector mutual funds in India as of March, 1996.
In spite of the problems it faced, many industry leaders were positive about the future:-
The sheer experience (bad) of direct investment will eventually turn people to Mutual Funds since risk diversification becomes a pre-requisite K.N. Vaidyanathan, Country Manager, Morgan Stanley Asset management India Pvt. Ltd.
NAV is the parameter used to rate the performance of MFs on a daily basis. In simplistic terms, it is calculated as the total worth of all the investments of a MF divided by the number of outstanding units/shares. NAV is equivalent to the market price of an open ended MF unit/share. Actual calculations involve adding to the total market value of a MFs assets the following: (i) Receivables, (ii) Accrued income, (iii) Other assets; and deducting the following: (i) Accrued expenses, (ii) Payables, (iii) Other net liabilities. The net figure obtained is divided by the number of outstanding units/shares to give NAV.
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Often investors compare units with those available in the primary market and expect a high listing price. They dont realise that it is a low risk, long term instrument that offers steady returns Vivek Reddy, CEO, ITI Pioneer.
Mutual Funds are only for those who have the patience to wait for three to five years M.M. Khurana, General Manager, SBI Mutual Fund.
With the capital markets getting more sophisticated and better regulated, and with large household savings still in traditional bank deposits, mutual funds have a huge potential. Once portfolio disclosure becomes transparent and NAVs are declared daily, investor confidence will re-emerge. Sanjay Jha Vice President, Alliance Capital.
The Decision
Analysts wondered why SFL was interested in starting a mutual fund in such adverse market conditions. In contrast, the Board of Directors of SFL, referring to the growth in sales of commercial vehicles of 24% during the year, looked forward to registering a reasonable growth in hire purchase and leasing business by adopting suitable funding and business strategies.8 In the long term, the demand for road transportation of goods in India was poised to grow substantially with a higher degree of industrialisation, growing urbanisation and higher standards of living. By 2000 AD, truck sales were expected to double to over 3,50,000 vehicles a year from about 1,70,000 in the year 1994-95.
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Of greater concern was the impact selling mutual fund units to investors would have on the companys existing investor base. Would SFLs small investors be able to understand the difference between a fixed deposit and an investment in SFLs mutual fund? In the event of a continuing downturn and an NAV below par, would SFLs reputation with investors be affected? What benefit would SFL get from the mutual fund as its earnings would be limited to its share in the profits of the Asset Management Company? These were some of the questions troubling the analysts as SFL seemed on the verge of announcing the launch of its new mutual fund.
27
EXHIBITS Exhibit 1: Category-wise number of NBFC schemes with net owned funds over Rs. 5 million (as of September 30, 1995). Source: Non-Banking Finance Companies, Banking Finance, July 1997. Scheme Category Hire Purchase Loan Investment Equipment Leasing Nidhis and Chit Funds Others Total Number 169 300 597 71 8 4 1147
Exhibit 2: Summary of SFLs financial performance over the years since inception. Source: Company Annual Report 1995-96, p.11). All figures in Rs. Crores.
YEAR PAID-UP CAPITAL RESERVES DEPOSITS STOCK-ON HIRE LEASE RECEIVABLES PBDT PROFIT AFTER TAXES DIVIDEND %
1955 1965 1975 1980 1985 1986 Jan-Mar'87 1987-88 1988-89 1989-90 1990-91 1991-92 1992-93 1993-94 1994-95 1995-96
0.07 0.60 1.00 2.00 3.00 6.00 6.00 6.00 6.00 6.00 12.00 12.00 12.00 12.00 12.00 24.00
0.31 1.08 2.26 7.84 6.59 8.00 15.08 19.83 27.23 30.24 53.40 79.02 115.34 159.79 204.31
0.20 1.73 11.76 26.28 86.49 104.10 108.39 127.93 144.16 167.64 201.02 226.03 262.83 351.69 431.03 550.44
0.57 5.58 21.40 47.14 118.62 135.47 143.94 153.42 200.02 278.47 380.87 435.11 554.27 714.85 920.59 1209.64
32.13 49.19 63.98 75.08 80.38 85.06 102.34 128.63 169.12 239.84 295.57 427.41
0.01 0.39 1.16 2.48 8.53 10.35 3.1 15.56 19.17 25.13 34.69 49.56 62.51 85.16 103.21 127.50
0.01 0.14 0.4 0.91 2.74 2.67 1.15 4.68 6.56 9.2 12.01 26.91 29.83 41.71 50.47 64.92
5.00 14.00 16.00 20.00 20.00 16.00 4.00 20.00 30.00 30.00 25.00 30.00 35.00 45.00 50.00 35.00
28
Exhibit 3: SFL Balance Sheet for the years 1995 and 1996 (as of March 31). All figures in Rs. Crores (Source: Company Annual Report 1995-96, p. 12) March 31, 1996 SOURCES F FUNDS 1. Shareholders Funds (a) Capital (b) Reserves & Surplus 2. Loan Funds (a) Secured Loans (b) Unsecured Loans March 31, 1995
24.00 204.31 228.31 542.02 596.66 1,138.68 TOTAL 1,366.99
12.00 159.79 171.79 486.95 439.18 926.13 1,097.92
APPLICATION OF FUNDS 1. Fixed Assets (a) Gross Block (b) Less Depreciation (c) Add: Lease adjustment account (d.) Net Block 2. Investments 3. Current Assets, Loans & Advances (a) Current Assets (b) Loans & Advances [A] LESS: Current Liabilities and Provisions (a) Current Liabilities (b) Provisions [B] 4. Net Current Assets (A-B) TOTAL
469.83 (209.49) 260.34 66.79 327.13 110.69 1,255.35 145.36 1,400.71
333.40 (163.01) 170.39 52.61 223.00 97.15 987.62 143.74 1,131.36
460.23 11.31 471.54 929.18 1,366.99
339.79 13.80 353.59 830.38 1,097.92
29
Exhibit 4: Profit and Loss Account for the years ending March 31, 1995 and 1996. All figures in Rs. Crores. (Source: Company Annual Report, 1995-96, p. 13). 31/3/96 Income Income from Financing Operations Other Income (A) Expenditure Financial Expenses Establishment Charges Administrative and Other Expenses (B) Profit before Depreciation and Tax Less: Depreciation Profit before tax and lease equalization account Add/(Less): Lease equalisation account Profit before tax Less: Provision for taxation Profit after tax Add: Investment Allowance Reserve withdrawn Add: Balance brought forward from previous year Amount Available for Appropriation Appropriations Dividend General Reserve Surplus Balance carried to Balance Sheet (A-B) 310.82 22.47 333.29 31/3/95 232.88 17.60 250.48
176.97 9.16 19.66 205.79 127.50 56.76 70.74 14.18 84.92 20.00 64.92 2.25 67.17
122.08 7.18 18.01 147.27 103.21 45.23 57.98 16.07 74.05 23.60 50.45 0.02 2.78 53.25
8.40 57.00 1.77
6.00 45.00 2.25
30
Exhibit 5: Instrument-wise annual distribution of Household Assets in crores of rupees. (Figures in brackets indicate percentage of total). Source: RBI, Currency and Finance 1995-96 (Vol. 11). 1980-81 12,117 1,625 (13.4) 5,550 (45.8) 378 (3.1) 915 (7.6) 2,122 (17.5) 712 (5.9) 412 (3.4) 31 (0.3) 373 (3.1) 1990-91 59,967 6,251 (10.6) 18,777 (31.8) 1,286 (2.2) 5,599 (9.5) 11,155 (18.9) 7,942 (13.5) 4,972 (8.4) 3,348 (5.8) -453 (-0.8) 1992-93 80,453 6,562 (8.2) 29,550 (36.7) 6,035 (7.5) 7,114 (8.8) 14,817 (18.4) 3,949 (4.9) 8,212 (10.2) 5,612 (7.0) -1,398 (-1.7) 1993-94 1,09,562 13,367 (12.2) 36,378 (33.2) 11,654 (10.6) 9,548 (8.7) 18,248 (16.7) 6,784 (6.2) 10,067 (9.2) 4,705 (4.3) -1,190 (-1.1) 1994-95 1,39,778 15,916 (11.4) 56,164 (40.2) 11,743 (8.4) 11,344 (8.1) 20,619 (14.8) 13,222 (9.5) 8,461 (6.1) 3,908 (2.8) -1,600 (-1.1) 1995-96 1,24,793 16,375 (13.1) 35,284 (28.2) 17,079 (13.7) 13,481 (10.8) 25,438 (20.4) 10,873 (8.7) 5,880 (4.7) 262 (0.2) 300 (0.2)
1 2 3 4 5 6 7 8 9
Gross Savings Currency Bank Deposits Non-bank Deposits Life Insurance Funds Provident and Pension Funds Claims on Govt. Shares and Debentures UTI Units
10 Trade Debt
31
Exhibit 6: Comparison of three top ranking NBFCs for the financial year 1994-95. All figures in Rs. Crores. (Source: CRISIL Rating Scan, April 1996, p. 50 for SFL and July 1996 p. 40 for KMFL and p. 62 for Cholamandalam). Company Equity Share Capital Networth Net Stock on Hire Gross Leased Assets Net Leased Assets Hire Purchase Income Lease Income PBT (Reported) PAT (Reported) Dividend/PAT (%) (Reported) Dividend Rate (%) Expenses/Assets Deployed (%) Total Debt/Networth (Times) SFL 3/95 12.00 171.79 675.54 316.80 212.88 150.46 68.76 57.98 34.38 17.5 50.00 1.90 5.40 KMFL 3/95 36.73 249.00 481.42 347.01 268.78 52.39 74.76 68.20 64.20 6.10 18.00 2.80 3.90 Cholamandalam 6/95 6/94 16.82 8.50 105.84 31.79 94.76 68.89 112.19 70.02 74.72 42.79 25.26 16.08 25.25 17.70 17.94 9.72 16.19 8.52 28.10 34.90 40.00 35.00 1.80 2.40 1.90 4.50
3/94 12.00 127.34 510.94 250.78 173.24 119.07 56.00 47.65 26.65 20.30 45.00 1.80 5.20
3/94 18.31 188.04 166.70 230.38 171.46 17.02 48.06 47.29 42.29 7.40 18.00 2.20
Exhibit 7: Mutual Fund Schemes. Source: Mastering Mutual Funds, C.M. Kulshreshta. Published by Vision Books Pvt. Ltd., 1994. Schemes floated by various Mutual Funds are essentially of two types, namely Open Ended and Close Ended. From the point of view of investment objectives, these may be further divided into Income, Growth, Balanced (Income + Growth) or Tax Saving Schemes. Open Ended Schemes: These are available for subscription all the year round excluding the period of bookclosure. They may or may not have a specified redemption period. For instance, UTIs Unit 64 Scheme has no prescribed time limit when it would be redeemed. The sale and repurchase prices are fixed by the mutual fund concerned from time to time. Repurchases are generally allowed at specified rates. Close Ended Schemes: These are open for subscription only during a specified period. Generally, the redemption is also specifies, and this means that they terminate on certain specific dates when the investors can redeem their units. The duration of the scheme may vary normally it is 5 7 years. Repurchase during the intervening period may or may not be allowed. UTIs Monthly Income Scheme is an example of a Close Ended Scheme. Income Schemes: These provide returns in the form of dividends. The returns may be cumulative or noncumulative on a monthly, quarterly, half-yearly or yearly basis. Since Mutual funds carry market risks, they are prohibited from declaring any guaranteed rate of return. (UTIs
32
Monthly Income Scheme is an exception). In view of the regular and steady flow of returns required by investors, the corpus is invested predominantly in fixed income securities, like debentures, bonds, government securities, while a relatively lower percentage is invested in equity shares. Growth Schemes: These are usually close ended. The aim of such schemes is to provide capital appreciation to their investors and accordingly, a substantial part of the corpus is invested in equities and convertible debentures. Such schemes are usually listed on the major stock exchanges and the capital appreciation is reflected in their market quotations. They may or may not declare dividends. However, the declaration of annual dividends signals to investors that the scheme is healthy. UTIs Mastershare 86 is an example of a growth scheme. Income + Growth Schemes or Balanced Schemes: The aim of such schemes is to provide both steady income as well as capital appreciation. Therefore, the investment is divided almost equally between debt and equity. For instance, the Centurion Prudence Fund 93 was an income + growth (balanced) scheme floated by 20th Century Mutual Fund with the declared objective of providing stable and periodic returns, and maximizing the total returns (dividend + capital gain) to investors had the following composition: Equity: Equity related instruments: Debt instruments: Money market instruments 30% 15% 50% 5%
Equity Linked Savings Schemes (ELSS) or Tax Savings Schemes: These are essentially close-ended growth schemes floated by almost all the public sector mutual funds in the last quarter of each financial year. They provide tax rebates to the extent of 20-25% upto a ceiling of Rs. 10,000. Their duration is generally 10 years, but repurchases are allowed after a specified period usually 3 years.
33
Exhibit 8: Mutual Fund Industry in 1994. Source: Mutual Funds Future Shock, Business India October 24-November 6, 1994, p. 54. (Size of assets Rs. 70,000 crores) Number of Players Number of Schemes Close Ended schemes Open Ended schemes Growth schemes Tax saving schemes Income schemes Balance schemes Others 14 142 130 12 38 37 28 34 4
Exhibit 9: Source Mutual Funds and Asset Preference, L.C. Gupta. Published by Society for Capital Market Research and Development, 1993.
Per cent of households owning the asset
UTI Units: Ownership incidence among household investors by income class

75.1 80 70.5 70 56.5 60 45 50 40.4 40 31 27.6 30 17.9 20 10 0 Upto 2501- 5001Over 2500 5000 10,000 10,000 Income Class (Rs. per month)
1990-91 1992-93
34
Exhibit 10: Source Mutual Funds and Asset Preference, L.C. Gupta. Published by Society for Capital Market Research and Development, 1993
Per cent of households owning the asset
New Mutual Funds: Ownership incidence among household investors by income class
70 60 50 40 30 20 10 0 65.7 45.1 29.5 15.1 10.3 5.4 Upto 2500 25015000 20.7 30.4 1990-91 1992-93
5001Over 10,000 10,000
Income Class (Rs. per month)
Exhibit 11: Source Mutual Funds and Asset Preference, L.C. Gupta. Published by Society for Capital Market Research and Development, 1993
Per cent of each age class of household investors holding UTI and New MF assets (1993)
Percentage of Holders 80 70 60 59.1 59.7 60.8 41.6 UTI Units New MF's 73.6
50 40.4 42.9 43.4 40.7 38.2 40 34 29.6 30 20 10 0 Upto 25 2630 3140 4150 5160
Over 60
Age-Group in years
35
Exhibit 12: Occupational Classification of Mutual Fund Investors in India (1993). Source Mutual Funds in India Marketing Strategies and Investment Practice, H. Sadhak. Published by Response Books, 1997. (Note: This data is limited by the exclusion of pure growth schemes. However, tax saving schemes may be taken as a proxy for growth schemes as they have no investment restrictions and invest about 80% of funds in equity related instruments.)
Occupation Income No. Amt. (%) (%) 4.24 4.06 20.17 14.11 17.14 14.72 2.62 2.47 22.43 20.71 33.4 43.93 TYPE OF SCHEME Income+Growth Tax-Saving Overall No. Amt. No. Amt. No. Amt. (%) (%) (%) (%) (%) (%) 6.03 6.03 6.49 6.90 5.18 4.81 25.37 18.45 51.5 45.04 32.43 21.63 19.41 18.23 22.87 27.99 19.44 18.01 3.56 4.37 0.30 0.35 1.77 2.04 21.18 20.66 3.15 3.56 14.98 16.64 24.45 32.26 15.69 16.16 16.20 31.87
Professionals Service Business Agriculture Housewives Other
36
Exhibit 13: Cumulative Resources raised by various Indian Mutual Funds in crores of rupees as of 1996. Source: Securities & Exchange Board of India, Annual Report 199596. No. Mutual Fund Income Schemes 25,970 458 754 54 110 93 64 Growth Schemes 8,625 353 1,528 338 504 982 576 228 93 304 249 229 162 150 98 133 108 93 74 71 20 Income & Tax Venture Total Growth Saving Capital Schemes Schemes Schemes 29,622 3,063 212 67,492 1701 709 2,764 200 577 2,763 195 222 1510 721 102 1381 982 37 722 252 66 638 202 156 422 105 130 328 304 249 48 229 218 60 210 1 193 1 170 108 12 105 74 2 73 21 41 41 41 5 5 33,046 5,209 212 81,027
1 2 3 4 5 6 7 8 9 10 11 12 13 14 15 16 17 18 19 20 21 22 23 24
UTI Canbank SBI LIC GIC Morgan Stanley BOI Indbank PNB Kothari Pioneer Taurus ICICI CRB Birla IDBI JM 20th Century Apple Tata Reliance Alliance Shriram BOB Jardine Fleming Total
56 46 36
27,640
14,919
37
Exhibit 14: Growth of Cumulative Resources mobilized by Indian Mutual Funds in crores of Rupees. (Source: Securities & Exchange Board of India: Mutual Funds 2000 Report and Annual Report 1995-96). Year 1986-87 1987-88 1988-89 1989-90 1990-91 1991-92 1992-93 1993-94 1994-95 1995-96 UTI 4,564 6,739 11,835 17,651 21,376 31,806 38,977 51,978 61,500 67,492 Other Public Sector MFs Private Sector MFs Total 4,564 6,739 13,456 19,111 23,060 37,480 46,988 61,301 75,050 81,026
1,621 1,460 1,684 5,675 8,011 8,407 10,550 10,451
916 3,000 3,083
38
References
1
From S. Venkitaramanan Non-bank Finance Banking Finance June 1997, pp. 33-34. This section draws on an article titled Case Study: Sundaram Finance in FT India Business Intelligence, Issue No. 40, July 12, 1995, published at London. 3 Changing with the times Business India December 16-29, 1996, p. 92 4 Changing with the times Business India December 16-29, 1996, p. 92 5 Business India October 24-November 6, 1994, p. 57 6 L.C. Gupta Mutual Funds and Asset Preference New Delhi: Society for Capital Market Research and Development, 1993. 7 Mutual Mistrust Business India January 1-14, 1996, pp. 70-71. 8 From Directors Report in 1995-96 Annual Report
2
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Indian Institute of Management Bangalore

Sundaram Finance Ltd.

Prof. Rishikesha T. Krishnan

Sundaram Finance Ltd.

Sundaram Finance Ltd.

Non Banking Finance Companies (NBFCs)

insurance companies, non-banking finance companies and mutual funds.

Sundaram Finance Ltd.

long before the modern banks.

Most entrepreneurs found it easier to raise funds from

one crore=ten million 3

Sundaram Finance Ltd.

The TVS Group

Sundaram Finance Ltd.

SFL - the beginnings

Sundaram Finance Ltd.

Sundaram Finance Ltd.

SFL - 1970s and beyond

Sundaram Finance Ltd.

Diversification into Leasing

SFLs Equity Base & Dividend Policy

Sundaram Finance Ltd.

A snapshot of SFLs operations

Sundaram Finance Ltd.

Top Ranked NBFC

Sundaram Finance Ltd.

Reasons for the success of SFL2

Sundaram Finance Ltd.

Sundaram Finance Ltd.

Sundaram Finance Ltd.

Sundaram Finance Ltd.

Sundaram Finance Ltd.

Government securities, banks and financial institutions:

Sundaram Finance Ltd.

Sundaram Finance Ltd.

The Unorganised (& unregulated) sector:

Sundaram Finance Ltd.

The Mutual Funds Diversification Decision

Sundaram Finance Ltd.

Growth of Mutual Funds in India over the previous 10 years

Sundaram Finance Ltd.

Sundaram Finance Ltd.

Policy on Private Mutual Fund Formation, Expenses and Remuneration

Sundaram Finance Ltd.

The Mutual Fund Industry in 1996

Sundaram Finance Ltd.

In the first half of 1995-96,

Sundaram Finance Ltd.

Sundaram Finance Ltd.

Sundaram Finance Ltd.

Sundaram Finance Ltd.

Sundaram Finance Ltd.

24.00 204.31 228.31 542.02 596.66 1,138.68 TOTAL 1,366.99

12.00 159.79 171.79 486.95 439.18 926.13 1,097.92

469.83 (209.49) 260.34 66.79 327.13 110.69 1,255.35 145.36 1,400.71

333.40 (163.01) 170.39 52.61 223.00 97.15 987.62 143.74 1,131.36

460.23 11.31 471.54 929.18 1,366.99

339.79 13.80 353.59 830.38 1,097.92

Sundaram Finance Ltd.

8.40 57.00 1.77

6.00 45.00 2.25

Sundaram Finance Ltd.

Sundaram Finance Ltd.