29th Nov 2011

WF : Uncertainty and fear seem to be the dominant mood right now - uncertainty in terms of markets as well as business models in fund management and distribution. Taking the first one - fear of where markets are headed - what do you see as the outlook for Indian equity markets over the next 12-18 months in an environment where both the global and domestic indicators are looking weak?

Sandesh : The market is going through extreme uncertainty because of both global and local factors. About one third of our floating stock is owned by the FIIs and about a third of our GDP growth rate could be attributed to global markets. In a sense we are closely connected with the global markets. The global fall in risk appetite because of the Eurozone problems has hit all emerging markets including India. Inspite of the downgrade of US, there is a flight to safety to US reflected in the drop in the US yields. The local parameters viz fiscal deficit, current account deficit, inflation, pressure on currency reminds one of the late 90s. The only difference being that of a robust growth vis a vis the late 90s mainly arising out of the domestic consumption. I think the Euro problem should slowly see a resolution in the next 6 months; it could go either way - an euro breakup, or continuation with greater fiscal controls or the peripheral countries leaving the euro. Our connection with Euro is mainly with the funding lines from the European banks, which to my view would get protected for sure. I don't see the possibility of a credit freeze as what happened in the aftermath of the Lehman collapse which I think was an accident and hence the market reaction. Issue is about the liquidity in the markets that can drive the markets which can happen from the FIIs only with the resolution of euro. When you look at the valuation , the last steep fall was in 2009 when sensex touched 8000, the valuation then was about 10.5-11 times forward earnings. I think the current valuations are not far from that valuation. In that sense markets would continue to become cheaper when it trades in a narrow range for a long time. I think equity as an asset class should outperform other asset classes in the next 2 to 3 years.

WF : Business confidence in the fund management and distribution businesses is running very low. How do you see the fund management business shaping up over the next 5 years? Is there room for 40 plus players or do you see consolidation ahead?

Sandesh : We have seen business confidence in the fund management and distribution business at a high when the underlying markets are doing well. However the underlying market volatility and the sharp drop in the fund expenses after the withdrawal of entry loads have forced the distribution to reassess their business models. The Mutual Fund continues to be the best vehicle for the investors to access equity markets both in terms of cost and convenience. The industry operates in the top 100 centres which would have about 90% of the total commercial bank deposits. In that sense the fund management business has a good reach. At a total AUM of about Rs 6.95 lac cr the potential is huge when we compare with the total Bank deposits of Rs 56 Lac cr. The total number of Banks aggregate to 69 excluding the cooperative banks and the RRBs against the total of 41 AMCs. Yes the entry barriers for the business have been on the rise. The current cost structure does not make it viable for any AMC to do direct marketing to customers, more so retail , and hence distribution is key for the survival of the Funds business. It is only the distributor that can provide an option to the investor. The AMC business in that sense is not very complicated. There is a top line coming out of the fees and there are expenses for distribution , manpower and infrastructure. The focus of the business has to be on providing a quality product with fund managers producing adequate alpha on their funds. The withdrawal of entry loads saw a steep drop in the cost of the products for the investor . The operating margins on the equity products have virtually vanished in the year of client acquisition. The focus has to be on increasing the longevity of the investment. It is only then that the business becomes viable. Any AMC should have a mix of Institutional and retail and focus on product performance and costs to make the business viable. Yes we would see consolidation of players not achieving growth .

WF : Distribution business is going through a fairly significant upheaval, with business models coming under close regulatory scrutiny. How do you see fund distribution evolving over the next 5 years and what are likely to be the key drivers of change in this business?

Sandesh : As mentioned earlier, distribution is key for the Funds business. The withdrawal of Entry loads have significantly reduced the possibility of mis-selling. The distribution , which was more of a paper pushing kind now has to be more evolved. The distribution has to graduate to look after both sides of the balance sheet of the customer. He would have to do financial planning on the asset side of the customer and also have to help the customer on his liability by arranging funds say in the nature of an auto loan or a mortgage loan etc. This would provide a complete open architecture solution for the customers and would go a long way in cementing the relationship with the customer. I also believe that there could be a large rise in the debt markets. Distributors could also facilitate investments into the debt markets both primary and secondary for the customers. On the fund distribution side I see a greater focus on building annuities through the sip sales. A pure fund distribution approach would change for sure. While access to public equities would largely happen through the fund route , other alternate asset classes like PE or real estate could see greater flows.

WF : There is a belief that as Indian markets mature, delivering alpha will become more challenging - like what we currently see in US and European markets. Do you agree with this belief or do you see India offering alpha generation opportunities in the foreseeable future? Is alpha generation the primary focus for your fund management team or is it consistency of performance vs benchmark?

Sandesh : I think every corporate goes through a capital market life cycle. In the initial phase of the capital market lifecycle, when the corporate is a tiny cap/ small cap/ midcap , in the developed markets this phase is captured by the VCs or the PEs. Therefore only when these companies become large , that they get listed and are accessible to the public fund managers. The high growth phase gets captured by the PEs/VCs. It is for this reason that we see almost 2/3rd of the Mutual fund managers underperforming the benchmarks in the developed markets. In India this number would be about 40% . The PE/VC activity in India too is on a rise and hence we may not see the large alpha seen in the past. We believe alpha generation is the primary focus of our Fund Managers. We believe a 3% alpha is a good enough target for a Fund Manager. This focus would bring about consistency of performance.

WF : What are the key steps that the industry needs to take to help grow its retail penetration beyond equity funds in large cities? How can fixed income funds and liquid funds be popularised across the retail savers population in the country?

Sandesh : The retail investors have predominantly been investing in fixed income securities viz the Bank deposits, the Postal products or the PPF. Their comfort has always been on guaranteed products. It is for this reason that we see a lower penetration of equity investors. Less than 1% of Indian population has invested in equity . In fact there could be more investors who have invested in equity markets through the mutual funds than through the secondary markets. The industry therefore has been focusing on the SIPs to get more long term money through retail investors. The Mutual Funds have been conducting Investor Awareness programs across pan India to improve financial literacy and make investors aware of the advantages of the mutual funds. Popularising of the funds with retail investors, be it equity or fixed income , can happen only through the distribution be it Banks,National distributors or the IFAs. While the HNIs have taken up aggressively investing into Liquid/fixed income funds retail investors have mainly invested in the MIPs. A Liquid fund is a good option to park surpluses till such time that the final use of the funds is not decided. On our part we continue to focus on sale of all products with the ultimate aim to enhance market shares across product and geography.

WF : How do you see the online channel growing for the industry over the next 5 years? Are we likely to see more of an online direct business or is it likely to be more advisor led?

Sandesh : I think online channels would rise for sure. Mainly driven by internet penetration. I am not sure of online direct business as ultimately the investor would consider investing in more than one fund and it would make sense for him to do so through an online portal of a bank or any other distributor that gives him an option across fund houses and products.

WF : Talk on share classes is again gaining ground. Do you think introduction of share classes is a step in the right direction? Will it help evolve a segment of fee based advisors who offer lower cost alternatives of the same funds - and thus have a stronger justification for charging fees?

Sandesh : The new concept note on distribution lays down the foundation for deciding whether a distributor is an Agent or an Advisor. As an Advisor would charge the customer for the advice, and hence it is an incremental cost , it makes sense to introduce a share class that would be at a lower cost.

WF : What are your key priorities at Kotak Mutual Fund over the next 12 months?

Sandesh : I think key priorities are to increase market share across products and geography. We are already present in about 80 cities, which to my view , allows us to cover over 100 cities . The focus would be on producing reasonable alpha across all our equity products.

WF : What advice would you give to your distribution partners at this critical juncture when many of them are re-evaluating the viability of their business models ?

Sandesh : Distribution is key to any investment product. Therefore future is indeed very good for financial advisors. As discussed, there is a need to have a solution based approach for customers. It cannot be a monoline activity any more. The customer should have an access for all products through the distributor. This access itself would push for superior financial planning from the distribution end.