“Show me the incentive, and I’ll show you the outcome” -Charlie Munger
If there is one big mega trend unfolding before us, it’s the stupendous growth of SIP investments in the market. In July 2023, the monthly SIP inflows hit an all-time high, surpassing 15,000 Cr. Since FY16, SIP inflows have grown at a CAGR of 19.8%. That’s a strong tailwind that can’t be ignored.
*Source: AMFI. Click on the image to enlarge
There are many ways to participate in the financialization theme. We can buy stock exchanges (BSE is listed & NSE is fairly liquid in the unlisted space), there are several brokers available (Angel One, ICICI Securities, 5Paisa, Emkay, etc.), or we can directly invest in AMCs (HDFC AMC, Motilal Oswal, Edelweiss, etc.).
Indeed, there is some cyclicality in the revenues of these players, given their close ties with market performance. However, a notable feature of these business models is their ‘pull-based‘ approach: while they create the products, they depend on external entities to handle the marketing and distribution.
Enter the Distribution Network: The Push-Based Business Model
You see, these companies need people to reach their products to the investors, predominantly in Tier 2 & 3 cities. Their role involves marketing, raising awareness, educating investors, and distributing these investment products. These professionals are known as distributors, handling products like mutual funds and insurance.
The push-based strategy lends greater tenacity to the business than the pull-based approach. Unlike an AMC that primarily sells its own products, a distributor boasts a diverse range spanning various AMCs and asset classes. The agility to transition between products and AMCs, all while continually attracting new clients, grants Mutual Fund Distributors a notable advantage over traditional AMCs or brokerages. This makes them a relatively better option to play the SIP investment megatrend.
It’s like knowing smartphones will be big this decade. Instead of picking one brand, I would choose an online store that sells phones from every company.
In this post, let’s delve into a company that recently made its debut in the secondary markets, establishing itself as the largest listed pure-play Mutual Fund Distributor.
Prudent: India’s 5th Largest Mutual Fund Distributor
Founded by Sanjay Shah in 2003 and with its HQ in Ahmedabad, Prudent Corporate Advisory Services stands as the fifth-largest Mutual Fund Distributor in India and the second-largest non-banking mutual fund distributor, only surpassed by NJ Wealth.
The company primarily engages in the distribution of mutual funds, insurance products, and stock broking. It manages an AUM of 63,000 Cr and serves 15 Lac customers across India.
They follow an open distribution model, which allows them to distribute mutual funds from AMCs regardless of their affiliation or fund size. Over the past five years, the company has expanded its Mutual Fund AUM by a CAGR of 28%.
*Source: Q1FY24 Investors Presentation
The business model is straightforward. The company deploys a large group of Mutual Fund Distributors, whom they refer to as partners. These partners are equipped with all the essential tools, training, and support to sell regular mutual funds. A portion of the company’s revenue is then shared with these partners.
As of July 2023, the company has approximately 27,462 distributor partners. They return about 65% of the commission earned to these distributors. Technically, they are like the raw materials of the company.
Prudent has three main business segments:
Mutual Fund Distribution: This segment contributes 82.4% of the overall revenue. This is where the cream is for the company and investors alike. You see, whenever you buy a regular mutual fund, you are essentially paying a commission to the distributor. This commission is a recurring revenue stream for the distributor. That means as long as you continue to hold that fund, the distributor will receive the commission, paid directly by the AMC and reflected in the total expense ratio you bear.
Insurance Distribution: To diversify from relying on a single product, the company started distributing insurance products (another high-margin product) in 2019. They focus on retail products which include term insurance and traditional products like par, non-par, and annuity plans. The large MFD base helps them cross-sell insurance to their existing investor base.
Since 2019, the insurance segment has grown at a CAGR of 61% (on a lower base, though), with its contribution to the overall revenue increasing from 0.2% in 2019 to 11.6% currently. Just like the Mutual Fund product, insurance is also a recurring and high-commission segment.
Stock Broking & Other Businesses: They have a legacy stock broking business, and the management is gradually downsizing it. The revenue share has decreased from 8.2% in 2019 to 3.6% currently. Apart from that, they offer fee-based products for loans, fixed income, properties etc, which collectively contribute around 1% to the overall revenue. Nothing significant to talk about it.
The Dynamics of Mutual Fund Distribution
When buying a Mutual Fund, you can choose the Direct or Regular option. In both scenarios, you will need to pay the TER.
Think of the Regular TER like this: it’s just the Direct TER plus some extra commission. There is an entire industry out there playing that commission game.
As of July 2023, the total AUM in mutual funds stands at 46.3 Lac Cr. Out of that, 45.7% are in Direct plans, and 54.3% are in regular plans. Even though many people are slowly switching to Direct plans, a significant number of investors still go with the Regular plan.
*Click on the image to enlarge
The mutual fund distribution market is broadly divided between four major players. Big banks such as SBI, HDFC, Axis, etc., command around 37% of the market. National distributors like NJ Wealth, Prudent, IIFL Wealth, etc., account for approximately 28%. Brokers, command around 4%, while the rest is with individual financial professionals. The market dynamics have broadly remained the same in the last 5 years.
Between 2016 and 2021, the top 10 big players grew their market share from 29.1% to 45.2%. Out of this group, SBI was the standout, with their AUM CAGR of 49.4% followed by Prudent at 32.5% CAGR.
*Click on the image to enlarge
Comparing the Big Players
Prudent’s biggest competitor is NJ Wealth (among the National Distributors). Prudent also faces competition from the mutual fund distribution divisions of wealth management firms such as Anand Rathi, 360 One, and Bajaj Capital.
Looking at market share based on Average Assets Under Management (AAUM) for FY 2022, NJ Wealth is on top with 8%. Prudent Corporate comes next with 3.4%. On the commission side, NJ has a market share of 12.5% and Prudent has 4.2%.
Among the big names in mutual fund distribution, only NJ and Prudent get more than 80% of their total income from this business. But, NJ is still ahead of Prudent when we talk about profit margins and earnings per client.
Over the last five years, though, Prudent has been growing faster. They have grown at a CAGR of 32.5% for AAUM and 34.4% for Commission respectively, which is better than most of their competitors.
*Click on the image to enlarge
Twin Challenges: Direct Plans and SEBI’s Oversight
In 2012, SEBI mandated that mutual fund houses offer products through a direct route in addition to using distributors. As a result, asset managers introduced numerous direct plan offerings starting in Jan 2013. Since then, there has been a steady shift from Regular to Direct plans. Equity mutual funds are especially attractive to distributors because they offer high commissions compared to other categories like Debt and hybrid funds. Over the past 5 years, the proportion of regular funds in Total Equity AUM has decreased from 82% to 75%.
*Click on the image to enlarge
Just like AMCs, the risk for MFDs also comes from the regulator. In the recent consultation paper released, SEBI plans to cap the maximum TER that mutual funds can impose. This is because, beyond a certain point, costs don’t proportionally increase with AUM, suggesting AMCs should decrease their charges.
SEBI is contemplating a structure where, instead of setting TER limits for individual funds, the cap would apply to the TER of an entire AMC. This would be differentiated for equity and non-equity segments and would consider the collective TER across all schemes, rather than individual ones. Basically, SEBI is trying to protect investors who shouldn’t be taken for granted by the AMCs.
SEBI’s projections indicate that if its proposed changes were in effect during FY22, the total fees charged to investors would have been 4.55% less across the industry. Consequently, a reduced fee for AMCs would mean lower commissions for mutual fund distributors.
*Click on the image to enlarge
What’s our take on this?
Prudent is currently trading at a market cap of ~4600 Cr. As of the TTM, it reported a Revenue of 648 Cr, an EBITDA of 182 Cr, and a PAT of 125 Cr. It is trading at an EV/EBITDA of 25 times and a P/E of 37 times.
The valuation appears a bit stretched when compared to its peers, such as Anand Rathi, 360 One, or even AMCs like HDFC & UTI. These companies are trading in the range of 20-30 times earnings; however, they are facing challenges with growth.
- People in Mutual Fund Distribution are familiar with NJ Wealth due to its success over the past three decades. However, it isn’t listed. We can play the same theme via its closest competitor, which is growing at a much faster pace (on a small base).
- The company aims to achieve a 1 Lac Cr AUM and targets to hit the monthly SIP flow of 1000 Cr from current 540 Cr, in the next three years.
- Prudent (or Mutual Fund Distributors in general) represent a more straightforward approach to the financialization theme than AMCs & brokers. This is primarily because of their extensive distribution and the diverse array of products they offer across AMCs & fund categories (such as Flexi cap, Large cap, etc). This adaptability is their main advantage; while an AMC might struggle to launch new funds frequently, MFDs can seamlessly transition between AMCs based on performance.
- While the proportion of Regular plans in Total AUM might decline, the overall market size could expand as more individuals begin investing.
- SEBI and the cap on TER might remain as the primary regulatory challenges for the industry. Perhaps, similar to the dynamic between RBI and banks, MFDs will gradually adjust to progress under continuous regulatory oversight, which is beneficial on a broader scale.
*Click on the image to enlarge
This article is for information only and should not be considered a recommendation to buy or sell any stocks.
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