Mutual funds or Asset Management Companies (AMCs) are pooled investment vehicles which provide a professional way of managing one's money.

Let's understand what's the business model for Mutual funds:

Understanding the revenues:

•  AMCs charge a 'Total Expense ratio' or TER from the clients, which is the money it receives for managing the money.
• TERs are charged as % of assets and can vary widely from as low as 0.002% to as high as 2.5%. This is an annual recurring charge.
• For example, ABC fund manages assets of 1000 cr and charges TER of 1%.
• In this case, revenues for fund will be Rs.10 crore for a year.

Understanding the expenses:

• Salary - Fund management involves hiring high quality fund managers and research analysts and hence their salaries is the biggest expense for MFs.
• Commissions - Distributors play a vital role in selling MFs and the distributor commissions is another expense for MFs.
• Sales & Marketing - MFs have to spend money to market their different schemes and is another expense.
• Other operating costs - This includes variety of expenses like rent, overhead expenses, legal fees etc.

Business economics:

• Most of the costs of AMCs are fixed in nature i.e. expenses will not go up linearly with increase in Assets Under Management (AUM).
• Equity MFs have higher TER as compared to debt MFs. Hence AMCs with higher % of equity assets are better.
• Active MFs have higher TER as compared to ETFs/ index funds. Hence AMCs with higher % of active assets are better.

Challenges in current times:

• Passive investing - AMCs are facing increasing pressure by the move towards passive investing as the TERs and hence margins are lower in those products.
• Regulations - SEBI has put strict limits on the TERs that can be charged by AMCs as well as on the number of funds an AMC can have in a category.
• Competitive intensity - Competitive intensity is rising in the industry with more players getting the SEBI approval for MF license.

Summary:

• Asset management is a good cash-generating business, but it needs a certain scale to be profitable.
• AMCs earn revenue through the TERs charged to the clients on an annual basis.
• Salary of fund managers and research analysts is the major expense for AMCs.
• Increase in passive investing is the biggest risk to the AMCs business model.

DISCLAIMER: This blog is solely for educational purposes and not to offer any investment advice. Please do your own research or consult a financial advisor before making any investment decisions.