Despite posing massive entry barriers, India’s banking and financial services industry is perhaps the ideal sector for technology disruption. Age-old banking behemoths have been slow to embrace technology or fully utilise it, but tech startups are relying on the ever-liberalising financial services policy to make inroads, slowly but surely.
This week’s major acquisition story where fintech startup Groww bought out the IndiaBulls mutual funds business underlines the ambitions of tech startups fuelled by billions of VC dollars. Four-year-old Groww has acquired 13-year-old Indiabulls Asset Management Company Limited (IAMCL), along with its trustee Indiabulls Trustee Company Limited for INR 175 Cr. The acquisition is subject to the approval of market regulator Securities and Exchange Board of India (SEBI), and is seen as a big deal within the fintech ecosystem by most observers. Given that Groww satisfies the eligibility criteria for mutual funds asset management business — opened up late last year by SEBI — there should be no hurdles in the launch of its MF business once it gets the go-ahead from the regulator.
Founded in April 2017, Groww has so far been a digital brokerage firm offering retail investors a seamless way to invest in mutual funds, stocks, fixed deposits, exchange-traded funds (ETF) and other investment asset classes through its mobile app and web platform. The company was founded by former Flipkart employees Lalit Keshre, Harsh Jain, Neeraj Singh, and Ishan Bansal and became a unicorn last month. With competition such as INDMoney, Scripbox, smallcase, Zerodha, Upstox, Paytm Money, ETMoney and several other investment tech platforms, Groww is part of a market that is seeing increasing technology deployment.
So why is Groww going after a traditional asset management company (AMC) given its tech pedigree and how does it tie into its overall vision of making investment easier for Indians? For this, we will have to see how the ambitions of the fintech industry are evolving — going from being enablers of bits and pieces of the BFSI value chain to owning the entire thing.
Fintech Startups Look To Converge With Banking Sector
No other startup epitomises fintech’s unbridled ambition more than Sachin Bansal-owned Navi Technologies. As we saw in Inc42’s special deep-dive into Bansal’s plans to make a $100 Bn tech-first bank in India, the road to owning the BFSI value chain is littered with regulatory hurdles. Navi went about acquiring businesses that allowed it to break through into the industry with Bansal himself having no prior BFSI experience. This strategy may not have worked for Navi — the company is still awaiting the banking licence it so dearly wants — but it may work for other companies that are also flush with fresh funds to acquire and grow inorganically.
One of the first hurdles to be cleared was allowing fintech startups and other smaller BFSI entities to enter the mutual fund (MF) business. In December 2020, SEBI relaxed the rules, allowing such companies to launch mutual fund products to “facilitate innovation and enhanced reach”.
With the new norms, entities can be considered eligible to sponsor and launch MFs, if they maintain a net worth of INR 100 Cr, until the time they can demonstrate profitability for five years. SEBI also required AMCs to maintain their minimum net worth continuously and not just at the year-end, which means any startup that enters the field has to be highly capitalised, like Groww is, having raised over $140 Mn till date.
The scale of the AMC business is put into perspective when one considers that the total assets under management (AUM) of the Indian mutual fund industry as on April 30, 2021 stood at INR 32.38 Lakh Cr (over $440 Bn), as per the Association Of Mutual Funds In India. India’s investment tech market is estimated to reach a market size of $14.3 Bn by 2025, as per Inc42 Plus analysis. That’s why the Groww entry into the AMC space is a big deal.
Experts say that the change in norms will facilitate the entry of tech startups in the mutual fund business, particularly the easing of the profitability criteria. The mutual funds AMC business dominated by big banks such as SBI, HDFC, Axis Bank, Kotak, ICICI (Prudential) as well as major institutional brokers such as Motilal Oswal, JM Financials and other corporation-backed entities could soon see VC-funded fintech players disrupting the market.
Rahul Jain, senior VP for research at TVS Wealth subsidiary International Money Matters (IMM), told Inc42 that competing with major banks is certainly possible given that even smaller AMCs have innovative products that offer low expense ratio and high returns. The long-tail nature of the market plus the fact that customer base shifts with the performance of the AMCs, means that there is always room in the market for a new player. But this also makes it harder for AMCs to dominate the market.
Groww is one of the first fintech startups to make a bid for an AMC, but there are others that will follow, Jain said. As such there will be plenty of new competitors, but the success will be dependent on the business model.
After the Tiger Global funding round, which took Groww into the unicorn club last month, cofounder Keshre told us the objective is to expand the product line and go deeper into Tier 2, Tier 3 base. “We are growing horizontally by launching new products like investing in IPOs, ETFs, gold and vertically by making existing products like stock investments deeper through more features such as advanced charts, derivatives trading etc,” he had said.
About expanding into new territories besides investments, he added, “On the lending front, I would say that we will do everything in internet finance eventually, but maybe one year or two years down the line depending on the product. But for the next one year, we are focussed on investment products — there are too many things to be done just in making investing simple.”
What Drew Groww To The AMC Space?
The Bengaluru-based investment tech platform also needs a big revenue boost in the current fiscal year to justify its valuation, after posting a loss in FY20 of INR 7.93 Cr, a 3,348% increase from a loss of INR 23 lakh (0.23 Cr) in FY19.
In FY20, Groww only recorded revenue of INR 76.16 lakh (0.76 Cr), with a little over INR 29 Lakh is income from operations, while the rest i.e. INR 47.12 lakh coming from profit from the sale of investments and interest on deposits from banks. Its expenses grew from INR 31.76 Lakh in FY19 to INR 8.69 Cr in FY20.
The move into AMC territory with the IndiaBulls acquisition means the company can now expect to earn a lot more from its investment operations. To understand this, one needs to understand how AMCs differ from brokerages.
Firstly, an AMC has fiduciary responsibility to help maximise the returns for its investors or clients because it can take decisions unilaterally to invest, diversify or withdraw funds, unlike a brokerage, which is offering advisory and stockbroking service, and has no fiduciary or regulatory responsibility to help investors get maximum returns. As such AMCs attract wealthier investors and HNIs since they do have a higher buying power. These funds are invested in pools, which allows individuals to invest in classes that are usually reserved for institutional investors.
From a business model point of view, AMCs charge investors a set fee or a fee that is calculated as a percentage of that investor’s total assets under management (AUM) with the AMC. In the latter case, as the value of the investment grows or falls, the payout for the AMC increases or decreases. Some AMCs even combine flat service fees and percentage-based fees based on performance.
As such, AMCs are a far more lucrative business than stockbroking. And Groww definitely needs a big shot in the arm for its revenue.
Groww Looks To Change The Mutual Funds Game
But experts such as Jain believe that there are plenty of challenges for any financial services company, let alone a startup that is new to the AMC game. Groww cannot simply expect to show up and win a big piece of the mutual funds game.
For one, SEBI keeps a tighter watch on the mutual funds market than the brokerage game. It regularly changes rules that could complicate compliance for startups entering the space, such as its recent skin-in-the-game ruling for compensation of fund managers to tackle insider trading, which reared its head last year.
In April 2020, six Franklin Templeton debt funds were shut down by the AMC, due to redemption pressure and lack of liquidity in the secondary market for the underlying instruments. The Covid-19 pandemic in 2020 has caused a severe liquidity crunch in the market, which resulted in many stocks crashing drastically in the first six months of the year.
The situation had stabilised since then till last month, a year after the six Franklin Templeton funds were shut down. However, the current surge in Covid cases and lockdowns in most major economic hubs could further impact the mutual funds market.
A Mumbai-based wealth manager who runs his own firm told us on the condition of anonymity that the three biggest challenges for any startup entering the AMC space are risk management, corporate governance and credibility.
“Risk management cannot be replaced by technology, whereas corporate governance and credibility are about who is on the board of Groww,” he said.
Without knowing these aspects, there is no way to predict how well Groww will do. The big AMCs have their own banks backing them up, whereas IndiaBulls did not have the same credibility as these AMCs, he added.
While the future of the AMC business is uncertain given the rapidly changing fintech market, revenue diversification is definitely one of the keys to success in the BFSI tech game. Paytm has shown this in the payments domain with its multifaceted play which includes UPI, payments banks, cards, wallets, investments and more. Can Groww do the same for investment tech starting with MFs?
Keshre said last month that the audience under the age of 25 in India is still a massive market, which Groww will continue to target. That tells us that Groww will actually look to build its mutual fund play on the back of the millions of users it already has, rather than a few thousand high net worth individuals, which is what most AMCs aim for.
IMM’s Jain said that it will come down to the innovation in the product. Even if Paytm launches its own MF products tomorrow, it still needs to prove its performance in the long run, despite having a big brand name in the market. “Even if 10,000 investors buy a Paytm scheme on the first day, it does not matter because the customer base will shift in six months if the performance is weak or the returns are low,” he said.
From the point of view of a competitive moat, Groww does have a huge user base of 15 Mn users who are primarily millennials who use its personal finance management (PFM) product. The startup could position its AMC business as an upsell for this base, providing bigger returns while charging AMC-like fees.
Jain added that startups that enter this field could leverage their customer base in creating MF products and they will also have to look at innovative bonds and ETFs that are coming up in the market. He added that there is scope for innovation in the debt mutual funds markets with investments in money market instruments such as commercial papers (CPs), certificates of deposits (CDs), government bonds such as Bharat Bond, treasury bills and more.
There are currently five debt schemes under the IndiaBulls AMC, but the debt market will be tight in the coming months due to the impact of the pandemic. Any redemption pressures can become a liability for a loss-making company.
Will Groww be able to turn the AMC game on its head in this manner by allowing its millennial secondary market investors to invest en masse in its own mutual fund schemes? It would not only dramatically increase the addressable base for mutual funds and value-addition through fintech, but it could very well determine the future of the financial services industry in India.