IIMA Consult Club Newsletter - Sept 2010 | Mutual Funds | Private Equity

Panorama

SEPTEMBER 2010 ISSUE THREE

•Overview of Asset Management Sector •Mutual Fund profiles •News updates

Asset Management Sector - An Overview
What is Asset Management? The Asset Management industr y comprises the activities of investors who pool their resources and allow a professional fund manager to invest them. Asset Management in India Although the mutual funds and Insurance sectors have been opened up to private players only 16 and 8 years ago respectively, the Asset Management sector grew by over 500% from 2003 to 2008 and venture funds have been allowed even more recently. The Indian equity Growth in Assets under Management market with its remarkable bull run throughout most of in INR crore this decade right up to the crisis has boosted major 500000 growth in the asset 375000 management industry. Even now, India stands poised at the 250000 threshold of major regulatory 125000 changes that can open up new 2003 04 segments like Real Estates and 05 0 06 Pension Funds to retail 07 08 09 investors and private and 10 foreign fund managers. The Asset Management Industry in India consists of a vibrant and rapidly growing mutual funds sector, an insurance sector that is dominated by unit-linked insurance plans, and venture capital funds, both domestic and foreign. Foreign Institutional Investors (FIIs) form a 1 Impact and aftermath of the Recession In 2008, the Asset Management industry in India declined by about 12 %. However, this negative growth was significantly lower than the global decline of 17% and the decline of 21% that the industry faced in the United States. Following the global recovery in 2010, Assets under Management (AuM) in India have increased by 14%. category that pool foreign retail or institutional funds and invest in Indian debt and equity. Private Equity funds, domestic and foreign, constitute a booming segment as well. Development

Th e As se t M an ag em en t sector grew by over 50 0% from 2003 to 2008.

Re g u l a t i o n o f F D I i n A s s e t Management Upto 49% investment is permissible through normal operating channels. For investment over 49%, there are increasing minimum capitalization requirements for foreign institutions as the percentage of investment rises, increasing upto a

minimum of $ 50 million for investment over 75%. Verticals: 1. Mutual Funds: A mutual fund is a professionally managed fund that pools money from many investors and invests typically in

b. Venture Capital: Venture Capital funds invest in several emerging companies or start-ups but rarely take a majority stake in any single company. 3. Hedge Funds: A hedge fund is an investment fund open to a limited range of investors that undertakes a wider range of investment and trading activities than traditional long-term investment funds. It pays a performance fee to its investment manager. 4.Insurance Funds: Insurance funds in India are dominated by Unit Linked Insurance Plans (ULIP). This is a financial product that offers life insurance as well as an investment like a mutual fund. Part of the premium paid by investors goes towards the sum assured and the balance is invested in equity, fixed-return or a mixture of both. In India, Insurance funds are regulated by the Insurance Development and Regulatory Authority (IRDA). 5. Exchange-traded Funds (ETFs): An exchange-traded fund is an investment fund traded on stock exchanges, much like stocks. Its valuation is linked to an index, ad it can only be traded by certain authorized participants. 6. Pension Funds:

The largest invest or in the world is Japan’s G overnment Pension Fund. It manages assets worth abou t US$ 250 billion.

invest in stocks expected to yield large capital gains while value funds invest in undervalued stocks. In India, the assets managed by mutual funds grew at a compounded rate of 61% annually from 2005 to 2008, while their market capitalization has grown from 3.4 percent to 7.2 percent in the last six years. This impressive growth was stalled by the economic downturn in 2009, but is now showing signs of recovery. Products 1. Systematic Investment Plan (SIP): A Systematic Investment Plan (SIP) is a vehicle offered by mutual funds to help small retail investors save regularly. It is similar to a recurring deposit with a bank, where an investor puts in a small amount every month. The ticket size for a SIP can even be less than Rs.1000. In India, SIPs are the fastest growing mutual fund product, with their share of the equity MF market increasing from 2% in 2005 to 15% in 2009. This growth is highlighted by the fact that it was undeterred even by the recession during 2008, when the equity mutual fund market as a whole decreased in size. The advantage offered by SIPs is that, over a period of time, the number of units purchased using the fixed periodic investment is inversely proportional to the price of each unit for each successive period. Hence, fewer units are purchase when the price is higher while more units are purchased when the price is lower. Hence, investors’ risk is reduced by the averaging effect this strategy has on the Net Asset Value (NAV). However, the NAV will decrease if the absolute unit price decreases in the long term. 2. Equity Linked Saving Scheme (ELSS): An equity linked saving scheme is equity mutual funds with Tax benefits. The advantage of an ELSS over other tax saving instruments such as National Savings Certificate and Public Provident Fund is that the lock-in period is only 3 years while for NSC it is 6 years and for PPF it is 15 years. However, the risk factor is higher in an ELSS. In India, ELSS is gaining popularity with its market share increasing from 23% in

• Private equity firm buys major ity control of an existing or ma ture lossmaking or stagnant firm • Restructures the organization and processes to ensure a turna round and increase profitability.

Leveraged Buyout

investment securities such as stocks, bonds, short-ter m money market instruments, other mutual funds, other securities, and/or commodities such as precious metals.

Sub-Categories: a. Equity Mutual Funds b. Commodity Mutual Funds c. Bond Mutual Funds

2. Private Equity Private equity is an asset class typically consisting of equity securities in operating companies that are not publicly traded on a stock exchange. Investments in private equity most often involve either an investment of capital into an operating company or the acquisition of an operating company. Capital for private e q u i t y i s r a i s e d p r i m a r i l y f ro m institutional investors. a. Leveraged Buyout (LBO): In a typical leveraged buyout transaction, the private equity firm buys majority control of an existing or mature lossmaking or stagnant firm and restructures the organization and processes to ensure a turnaround and increase profitability.

Pension funds derive their funds from the deferral of income by employees and invest it on their behalf to provide a source of income after retirement. The largest investor in the world is Japan’s Government Pension Fund. It manages assets worth about US$ 250 billion. According to a Morgan Stanley estimate, pension funds worldwide manage around US$ 20 trillion in assets, which is more than the GDP of the United States. In India, pension funds are regulated by the Pension Fund Regulatory and Development Authority (PFRDA).

Equity Mutual Funds Equity mutual funds are the most common type of mutual fund worldwide. They can be broadly classified on the basis of their investment strategy into Growth and Value Funds. Growth funds 2

2003 to 38% in 2009. The top five ELSS in India typically give returns of 25–30% Distributors 1. Independent Financial Advisors: Numbering over 100,000, IFAs sell a number of financial products besides mutual funds. Many of them are dormant or inactive. 2. Banks: Both Private and Public sector banks sell mutual fund products to their customers through their branches and wealth relationship managers 3. National and Regional Distributors: They have an organized setup, with branches and sales forces to promote and sell mutual fund products. Examples of distributors are Bajaj Capital Ltd. And NJ India Invest. 4. Direct Channels: This refers to the direct sale of mutual fund products to customers by Asset Management Companies (AMCs) through their offices and online channels. Customers The three main categories of investors are small retail investors, corporates and high net-worth individuals (HNIs). Small

retail investors, who invest under Rs. 5 lakh, account for 99% of the investment volumes, making them a very important target segment for mutual funds. Also, their average tenure of investment is 30 months, the highest for any customer segment in the industry. However it must also be noted that they contribute to only 60% of the revenues of the industry. HNIs and corporates, on the other hand, are less likely to have a long holding duration but they are also less likely to redeem shares during turbulent times in the markets. Thus, the trade-off for mutual funds is between concentrated money from HNIs that is unlikely to stay when markets are booming, but will ride out bad times, and diluted funds from retail investors which have longer holding durations in a stable market but diminish when signs of instability appear. Regulatory Authority for Mutual Funds Securities Exchange Board of India (SEBI) is the regulatory authority of MFs. SEBI has the following broad guidelines pertaining to mutual funds: 1. All MF schemes should be registered with SEBI. 2. MFs should be formed as a Trust under Indian Trust Act and should be o p e r a t e d by A s s e t M a n a g e m e n t Companies (AMCs). A Trust comprises of a specified number of Trustees, who hold

the legal title to the assets of the fund, but have a fiduciary duty to the shareholders of the fund. 3. The net worth of the AMCs should be at least Rs.5 crore. 4. MFs should distribute minimum of 90% of their profits among the investors. There are other guidelines also that govern investment strategy, disclosure norms and advertising code for mutual funds. Removal of entry load and its impact on MFs Entry load is the charge levied by mutual funds when a customer buys into the fund. Mutual funds also charge a management fee for the holding duration and an exit load before redemption. Until recently, entry load was present in the Indian MF market and it motivated distributors to push volumes of MFs which offered them higher incentives. The removal of entry load in August 2009 was intended to ensure that MFs are judged solely on the basis of their perfor mance, creating g reater accountability and transparency in the MF market.

Mutual Fund Profiles
SBI Mutual Funds SBI Mutual Fund is a 20-year old mutual fund with an investor base of over 5.8 million. It was set up as a joint venture between State Bank of India and Société Générale Asset Management, France. The fund manages over Rs. 38,782 crores of assets across 38 active schemes. SBI MF’s Equity Funds include diversified Equity Funds, Sectoral Funds and Index Funds. SBI MF also offers equity schemes segregated by market capitalization of stocks (midcap and largecap) as well as by sectors (pharma, IT and FMCG). Besides equity schemes, it also offers a number of debt schemes and a gold ETF. Reliance Mutual Fund Reliance Mutual Fund has Average Assets Under Management (AAuM) of Rs. 1,04,511 crores and an investor count of over 73.30 Lakh folios. It is a part of the Anil Dhirubhai Ambani Group (ADAG) and its schemes are managed by Reliance Capital Asset Management Limited., a subsidiary of Reliance Capital Limited. RMF’s equity funds include growth funds, diversified equity funds, ELSS and SIPs. It also advertises a Quant fund which uses mathematical modeling to make its investments. While most of its schemes are open ended, its ELSS is a 10-year close ended scheme. It also has natural resources and infrastructure equity funds among its range of products. RMF offers a range of debt funds that invest in debt and money market instruments of varying risk. Among its other products are a Banking ETF linked to the CNX bank index, a gold ETF linked to the price of gold and fixed maturity plans. ICICI Prudential ICICI Prudential is sponsored by Prudential plc, one of UK's largest players in the insurance & fund management sectors and India’s second largest bank, ICICI Bank. Founded in 1998, ICICI Prudential now has Average Assets under Management (AAuM) of INR 68,742.64 crore. ICICI Prudential offers equity, debt and gold exchange traded funds. Among ICICI Prudential’s equity funds are Infrastructure, Service industries, IT and FMCG funds. It also offers tax-saving schemes.

Vedanta to buy majority stake in Cairn India
Vedanta Resources plc, the first Indian manufacturing company to be listed on the London Stock Exchange and the world’s fifth largest miner, has agreed to buy majority stake in Cairn India, the local arm of Britain's Cairn Energy. Cairn Energy is selling up to 51% of it 62.37% stake in Cairn India to Vedanta, in a deal that could see the Anil Agarwal owned Vedanta spending up to $9.6 billion. Cairn Energy has said that it will seek government’s consent and endorsement for selling its stake in Cairn India. The Oil Ministry has appeared uncomfortable at a non-oil firm gaining control of a company whose main property is the Barmer district oilfields in Rajasthan. However, the ministry is unlikely to stall the deal given that Cairn India’s contract with the government for the properties in question does not provide for a change in control at the corporate level. Moreover, 100% FDI is allowed in Oil and Gas exploration, restricting government action. The proposed deal has also not gone down too well with the state-run Oil and Natural Gas Corporation (ONGC), which owns a 30% in the Rajasthan oil block of Cairn India. In a letter to Cairn Energ y Plc Chief Executive Bill Gammell, ONGC Company Secretary NK Sinha said that the Edinburgh-based firm required "consent of ONGC besides other gover nmental approvals to consummate the proposed" sale. Following the announcement of the proposed deal, Vedanta’s Credit Ratings were downgraded by Fitch and it was placed on Creditwatch negative by S&P. These stem from the risk in the deal, given Vedanta’s lack of experience in the oil sector. India currents imports 70% of its oil usage. With the entry of Vedanta, and its aim of drilling for more oil in India, this deficit may see a fall. The primary issue lies with Vedanta’s inexperience in this sector, and it would be interesting to see how Vedanta proceeds in case the deal is allowed.

Please send in your suggestions and comments to teamconsult@iimahd.ernet.in

Team Consult Amber Maheshwari Agam Khurana Bharati Agarwal Chaithanya Rao Girish Gupta Gurveen Bedi Hemant Chhabra Kommu Nageen Mohit Garg Murali Nair Neeraj Huddar Nilesh Kumar Gupta Richa Gupta Simit Batra Utsav Kheria Vamsi Krishna Vivek Iyer

Mahindra & Mahindra to acquire South Korea’s SsangYong
Mahindra & Mahindra (M&M) has signed a Memorandum of Understanding (MoU) to acquire South Korean auto maker SsangYong Motor Company (SYMC). The deal is valued at close to $ 500 Million, making it the second largest outbound acquisition in the automotive space. The deal is expected to close in November. The strategic intent behind this acquisition is worth a closer look. SsangYong would give M&M access to more than 1400 dealers in almost 100 countries. Of special interest, is access to markets in Russia, Europe and Latin America. Access to the US market is also valuable as M&M has not been successful in its past efforts to create a viable distribution in the US. The two companies would also share their R&D and production platforms resulting in huge cost savings. This will also help the companies launch new products with a reduced lead time. Mahindra & Mahindra launched the SUV ‘Xylo’ seven years after the launch of its flagship ‘Scorpio’ in 2002. SsangYong has not launched a new product in the last four years. M&M also intends to bring in SsangYong’s existing products to the Indian market. Mahindra currently does not have any presence in the above Rs. 10 Lakhs market segment in India and SsangYong’s SUVs like the Rexton, Kyron and Actyon are expected to fill up this void. The product portfolios of the two companies complement each other extremely well. Overall, the move seems to be a perfect fit in M&M’s target of becoming a big player within the niche of utility vehicles and having a global presence in this market.

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