AMCs look strong but high valuations risk sharper fall in downturns

Companies have strong cash conversion, predictability and growth runway

Given gains in equity prices, it is not surprising that the earnings of asset management companies (AMCs) are growing quicker. The earnings momentum looks set to continue. Good fund performances have thus led to AMC earnings upgrades although valuations are high.

Recent market performance and net flow trends have led to earnings upgrades by between 3-8 per cent for FY25-27. Stronger equity AUM and earnings growth is expected for HDFC AMC and for Nippon (NAM), given superior fund performances. Both have strong systematic investment plan (SIP) books and manage several high-performing funds.

Valuations reflect this. AMCs trade at 50 per cent premium to the broader market – the AMC industry is at a one-year forward PE (price to earnings) of around 33x versus a Nifty forward PE of 22x. HDFC and NAM are at valuation premiums to sector peers like Aditya Birla Sun Life AMC (ABSL) and UTI AMC. For both ABSL and UTI, higher performance in mainstream funds remains a key monitorable. ABSL may deliver a comparatively better performance and it has a higher SIP contribution.

Inflows for May and June indicate Q1 FY25 investment momentum remains strong. There was a blip in March but that was followed by recovery. Flows continue to be stronger in smallcap, midcap, and sectoral and thematic funds, compared to largecaps. This could lead to share price surges in specific market segments as sector / thematic funds will have to chase performances.

Across the listed AMCs, there remains a gap between HDFC (where performance is led by balanced and flexi funds) and Nippon (led by large and flexi cap), because these two are garnering stronger flows compared to ABSL and UTI.

RTAs (registrar and transfer Agents) may also be worth looking at since their volumes are a direct play on the mutual fund (MF) industry, and CAMS and Kfin have developed other revenue streams. RTAs offer good operating leverage but there are higher fee pressures, given revenue concentrations of large clients. Again, valuation may be an issue since RTAs are also valued high.

CAMS (up 70 per cent) and Kfin (up 100 per cent) have delivered strong returns in the past year, led by strong growth especially in equity MF AUMs as well as growth in non-MF related businesses such as alternatives, issuer solutions and KYC registrations. They exist in a duopoly relationship with entry barriers creating moats and client lock-ins. Operating leverage is driving margin improvement. But high revenue concentration means the pricing power lies with AMCs. In the mid- to long-term, a higher share of direct investing will reduce dependence on transfer agents and this could result in yield compression and revenue declines.

The forward valuations of AMCs indicate strong re-rating due to strong fund performances. While earnings quality and growth potential of AMCs and RTAs seems good, valuations require inflows at current levels to sustain.

Higher fund performances by HDFC and Nippon have led to outperformance from both. AMCs have strong cash conversion, high degrees of predictability and growth runway and performance is easily monitored on a daily basis. But the P&L accounts of AMCs are exposed to market drawdowns. Superior fund performance will continue to drive stronger share of flows for HDFC and Nippon, and this will lead to higher CAGR. Peers ABSL and UTI have more reasonable valuations, and this factor could offer better defensive values in a downturn.

The segments (AMCs and RTA) are high-beta plays on the markets and likely to deliver excess returns while the bullish momentum remains. However, this also implies a downturn may lead to sharper declines.