I am looking at buying AMC stocks like HDFC AMC and Reliance AMC at current valuations. Would you recommend the same?

Before you get into buying AMC stocks there are two important things for you to know. There are only 2 listed AMC stocks today viz. HDFC AMC and Reliance AMC. However, of these two, Reliance Capital has sold off its entire stake to Nomura and it is not involved in the AMC business any longer. HDFC AMC has recently made a temporary provision in its AMC worth Rs.500 crore to compensate the FMP holders of HDFC Mutual Fund. You must be aware of these facts before buying these AMC stocks. However, you can base your decision to buy or not to buy AMC stocks on the following factors.

· AMCs are not valued like typical companies wherein you use P/E, P/BV etc. AMCs are valued based on the yield on AUM. That is because, when an AMC business is sold, it is valued based on what percentage of the AUM, the buyer is willing to pay. While there no hard and fast rule, there are some benchmarks you can consider. Reputed funds with a higher exposure to equity funds in their AUM command a pricing of 7-8% of the AUM. If you look at HDFC AMC then on an AUM of Rs.350,000 crore market cap of the AMC is already Rs.38,000 crore, the stock is already quoting at more than 11% of AUM. That is higher than what AMCs with a strong equity franchise command. Unless the AUM grows by leaps and bounds, it is hard to justify this price.

· SEBI has been putting pressure on AMCs to reduce costs and that has led to Margins narrowing. Now, the biggest source of revenues for the asset management companies comes from the fees charged by the AMC in the form of total expense ratio (TER). This poses two challenges for the AMC stocks. Firstly, SEBI has already taken steps to reduce the costs for mutual fund investors and that will hit AMC profits. Secondly, with Nifty and Sensex at all time highs, investors may be unhappy to pay TERs and may even shift to Direct Plans.

· Above all, there is the FMP uncertainty for AMCs. As of now there is no solution in sight. What happens to FMPs which have been used to fund promoters via pledged shares? Promoter funding by MFs is estimated to be to the tune of Rs.3.2 trillion with nearly Rs.1.2 trillion coming up for redemption in the next few months. How it impacts the valuation of AMCs remains to be seen, but it surely is going to create a sticky situation for AMCs.

As an equity investor you need to consider all these factors. The best thing is to wait and see how these AMCs handle the pressure over next few months and then take a call on these stocks.