Case Analysis -3

Indian Institute of Management Bangalore Sundaram Finance Ltd.

By

Prof. Rishikesha T. Krishnan Corporate Strategy & Policy Area This case has been written by Prof. Rishikesha T. Krishnan with assistance from Dwarakaprasad Chakravarty, PGP, Class of 1999 based on publicly available information, with financial assistance from the Centre for Development of Cases and Teaching Aids, IIM Bangalore.

Sundaram Finance Ltd. Case written by Prof. Rishikesha T. Krishnan, IIM Bangalore ©2001 Indian Institute of Management Bangalore

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Sundaram Finance Ltd.

Despite being the largest non-banking finance company (NBFC) in India (in terms of

asset base), Sundaram Finance Ltd. (SFL) was slow to take any new initiatives in the

“liberalised” economic environment of India in the early 1990s. While recent entrants to

the financial services industry had made visible and aggressive forays into a variety of

fund-based and non fund-based activities, SFL continued to stick to its conventional hire-

purchase business and concentrated mainly on truck finance. By 1995, SFL had made a

small beginning in the securities business and as a merchant banker through newly

created subsidiaries. In 1996, some analysts were concerned about the reported move of

SFL to start a mutual fund as the net asset value of most mutual funds was below par.

They were worried that entry into the mutual fund business could dilute the image of

reliability and safety, which SFL had built up over the preceding 42 years. Other analysts

believed that this could be the first major move towards transformation of SFL from a

strong niche player to a financial powerhouse.

Non Banking Finance Companies (NBFC’s)

The Indian financial sector has two broad segments – organised and unorganised. The

organised segment includes commercial banks, development finance institutions,

insurance companies, non-banking finance companies and mutual funds.

Non-formal sources of finance existed in India before commercial banks emerged. The

moneylender, the chit fund, and mutual credit societies were part of the financial scene


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long before the modern banks. Most entrepreneurs found it easier to raise funds from

non-banks rather than from banks. For instance, the rise of India’s film industry would

have been impossible but for non-bank finance.1 From a mere Rs. 3,161 crores∗ in 1984,

aggregate NBFC deposits stood at somewhere between Rs. 10,000 and 15,000 crores by

1994. There were over 40,000 NBFC’s in India in 1994.

Except for issuing chequebooks and handling small cash transactions, NBFC’s perform

similar functions as banks. NBFC’s have progressively been subject to reserve

requirements on almost the same lines as banks. The Reserve Bank of India has been

authorised to determine the policy and issue directives from time to time to the NBFC’s

regarding income recognition, accounting standards, asset classification, provision for

non-performing assets and capital adequacy.

NBFC’s mobilise funds from depositors just as commercial banks do. As the risk

associated with NBFC deposits is greater than with bank deposits, depositors receive

higher rates of return on their funds. NBFC’s disperse these funds through:

Hire Purchase: These are schemes for financing the acquisition of commercial and

private vehicles (generally trucks and cars), as well as plant and machinery. The loans are

secured by the purchased asset.

Loan Schemes: These schemes finance industrial projects and real estate acquisitions.

∗ one crore=ten million


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Investment Schemes: The funds mobilised are used to purchase corporate and

government securities and other money market instruments.

Equipment Leasing: These schemes finance leases of industrial equipment (plant and

machinery)

Nidhis and Chit Funds: Here, the mobilised funds are loaned or distributed among the

depositors themselves in a variety of ways.

Exhibit 1 shows the Category-wise distribution of NBFC schemes with net owned funds

over Rs. 5 million (as of September 30, 1995)

The TVS Group

SFL was promoted by T.S. Santhanam, the son of T.V. Sundaram Iyengar, one of the

early industrialists of south India. From Iyengar’s early ventures in the field of road and

bus transport and a dealership for General Motors in the early twentieth century emerged

the TVS group as a diversified business family with interests in a whole range of

automobile and transport-related businesses. While SFL itself was founded by Santhanam

in 1954, the major growth of the group took place in the 1960s.

In the 1960s, the TVS group set up a string of automobile parts manufacturing units,

largely with foreign collaboration. Among the companies that were promoted were

Lucas-TVS (auto-electric systems), Brakes India (brakes), Sundaram Clayton (brake-


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linings), Sundaram Fasteners (fasteners), Wheels India (wheels) and Sundaram Abex

(brake linings). These companies were founded by Santhanam and his three brothers, T.S.

Krishna, T.S. Rajam and T.S. Srinivasan. Santhanam is credited with having arranged

the finances for these new ventures.

By the early 1990s, the companies of the TVS group were being run largely by the third

generation of the TVS family. Management control of these companies had been divided

among the different branches of the family though ownership remained diffused as most

of the companies had been promoted by the group holding company, TVS & Sons Ltd.

However, SFL was promoted by Santhanam and his associates, and his branch of the

family was in total control of the company.

As of 1992, the TVS group companies had a combined sales turnover of approximately

Rs. 2,000 crores, making them one of the largest industrial groups in India. However,

their growth had not kept pace with some of the other industrial families who were their

contemporaries or with new entrants like the Ambanis of Reliance or the Ruias of the

Essar group. The TVS group’s image was one of solidity and conservatism with a

reputation for quality.

SFL - the beginnings

T.S. Santhanam had worked in the family business since 1930. He was responsible for

the successful creation and operation of the country’s “most successful insurance


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company,” the Madras Motor and General Insurance Company (MMGIC) which was

subsequently nationalised by the government of India.

To help small transport operators who were being exploited by moneylenders, he set up

SFL as a subsidiary of MMGIC in 1954. In the early days, bank finance was not available

for hire purchase and it was only in 1956 after the amendment of the State Bank of India

Act that companies like SFL could have access to bank funds against receivables. Even

then, SFL was one of the few companies to have access to this facility.

SFL started on a small capital base of Rs.0.02 crores and by end-1955 had stock-on hire∗

of Rs.0.57 crores. SFL earned a profit of Rs.0.01 crores in that year and declared a

maiden dividend of 5%. At the end of a decade, in 1965, SFL had reserves of Rs.0.31

crores, stock-on-hire of Rs.5.58 crores and deposits on hand were Rs. 1.73 crores. For a

summary of SFL’s financial performance over the years since inception, see Exhibit 2.

∗ Stock-on-hire is calculated as agreement value of the assets financed through hire purchase less the payments received


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SFL - 1970s and beyond

SFL had its one and only public issue of capital in 1972 in the form of an offer of sale by

the promoters of 100,000 shares (representing 10% of the equity) at a price of Rs. 13.50

per share. This enabled the public listing of the company and SFL became the first NBFC

listed on the Madras Stock Exchange.

SFL continued to grow slowly but steadily during the 1970s. The industrial climate was

weak following the socialist policies of the then government of India. The transportation

sector went through a particularly stressful time in the wake of the nationalisation of bus

routes in 1970. There were persistent rumours that the road transport industry would also

be nationalised and these had a negative impact on the demand for trucks and hence the

demand for truck finance. During this phase, stresses also appeared within the TVS

family and the first steps to divide managerial control amongst different members of the

family were initiated.

In spite of these problems, by 1975, reserves had risen to Rs.1.08 crores, stock-on-hire to

Rs.21.40 crores and deposits to 11.76 crores. SFL entered the 1980s with reserves of

Rs.2.26 crores and stock-on-hire of Rs.47.14 crores. Deposits had risen to Rs.26.28

crores and net profit for the year was 0.91 crores in 1980.

SFL’s growth was much faster and smoother during the 1980s and 1990s during which

India managed to break out of the “Hindu rate of growth” and achieve higher levels of

economic development. Reflecting this, by 1995-96, SFL’s reserves had swelled to


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Rs.204.31 crores, stock-on-hire to Rs.1209.64 crores and deposits to Rs.550.44 crores.

Net profit for the year was Rs. 64.92 crores.

Diversification into Leasing

Till the early 1980s, SFL’s principal business was truck finance. The opening up of the

leasing business provided a new opportunity for growth and SFL decided to enter the

leasing business in 1981. To focus more specifically on the leasing business, SFL created

a subsidiary company, India Equipment Leasing Ltd. in 1983 with equity participation

from the International Finance Corporation, an associate of the World Bank.

SFL subsequently entered the leasing business on its own as well. By 1995 about one-

fourth of the company’s receivables were on account of plant and equipment leasing and

the remaining three-fourths in Hire Purchase receivables. While some industry sources

believed that SFL was a player in the leasing business only for the tax shelter that leasing

offered, this was denied by SFL’s top management: -

“We don’t believe in tax shelters”

– T.S. Santhanam, Founder and Chairman, SFL.

“Leasing is a profit centre for us. It is a different source of operational funding for the

industry. How can we ignore it?”

- G.K. Raman, Managing Director, SFL.

SFL’s Equity Base & Dividend Policy


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From a small equity base of Rs.200,000 in 1954, SFL’s equity base had risen to Rs.24

crores in 1996. It is believed to be the only NBFC never to have diluted its equity through

public or rights issues. SFL has rewarded its investors with continued dividends and

bonuses. Bonus issues account for 96.7% of its capital. An investor who bought SFL’s

share in 1972 for Rs.13.50 earned a return of 840% over the next 24 years. SFL has

maintained a fairly consistent and conservative policy regarding dividends. Dividend

payout increased five-fold between 1987-88 and 1994-95 while profit after tax increased

more than ten times during the same period.

A snapshot of SFL’s operations

As of 1996, truck financing contributes about 73% to SFL’s disbursements, automobile

financing takes up 14% and leasing the remaining 13%. These activities are funded

through internal accruals, bank borrowings and from the market by way of fixed deposits.

Fixed deposits from individual investors constitute around 50% of SFL’s borrowings.

The total cost of funds works out to around 20% including about 3% towards overheads

and the cost of procuring funds. Typically, truck financing costs 26-28% per annum.

Therefore, SFL enjoys a spread of 6-8%. See Exhibits 3 and 4 for SFL’s balance sheet

and income statement for the financial years 1995 and 1996.

Credit Rating


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SFL’s fixed deposit programme enjoyed a credit-rating of FAAA from credit rating

agency CRISIL (April, 1996), indicating the highest degree of safety regarding timely

payment of interest and principal. CRISIL attributed this rating inter alia to

(i) A strong and committed management team.

(ii) Highly efficient operating systems, including credit appraisal and credit

monitoring.

(iii) A low likelihood of a tenor mismatch between the sources and deployment of

funds – due to high renewal rate of fixed deposits.

(iv) Strong financial flexibility arising from its investments in shares and debentures

of corporates, its bill discounting∗ portfolio and real estate owned by the

company.

(v) Conservative accounting policies.

Top Ranked NBFC

According to a study conducted by a research agency in 1996, SFL emerged as the top

NBFC. This ranking was based on the hybrid average weighted score methodology which

was believed to be a rigorous means of determining the aggregate financial, operational

and market strength of an NBFC. The top 10 companies in descending order of ranking

as per this study were Sundaram Finance, Reliance Capital, Kotak Mahindra, Tata

∗ Firms in need of working capital may approach banks and NBFC’s with bills of receivables. The bank or NBFC may then provide a discounted amount, which is equivalent to the present value of the receivable (depending on the risk involved). This process is known as bill discounting


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Finance, Lloyds Finance, CRB Capital Markets, SRF Finance, Cholamandalam

Investment and Finance, Anagram Finance and Ashok Leyland Finance.

Reasons for the success of SFL2

Sharp focus, commitment to values of fairness, honesty and integrity, and very high

levels of customer service are some of the reasons for SFL’s success. See Box below for

SFL’s corporate objectives and corporate philosophy.

OBJECTIVES • To channelise household savings • To assist small road transport operators • To provide lease finance to industries (from 1981) CORPORATE PHILOSOPHY • Truth and fairness guide the management of finance. • Customer satisfaction through excellent service and reliability. • Prudence and conservatism in financing operations. • Truth honesty and efficiency in all dealings. • Professional management with highest standards of integrity. • Full compliance with all laws and regulations. Source: http://www.sundaramfinance.com

Enabling the growth of SFL has been the loyal support of a growing base of small

depositors. While most of the depositors were originally from the south Indian state of

Tamil Nadu where the company was founded, by 1996, the depositor base had become

more diversified. While offering interest rates only slightly above the rates offered by

public sector banks, SFL has managed to build a strong and loyal customer base.


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This has been possible due to the image of trust and integrity enjoyed by the TVS group

to which SFL belongs, but also due to the efforts by the company to build customer

support. Its customer-friendliness is legendary. Some years ago when the staff at the State

Bank of India where many of its depositors bank, was preparing to go on strike, the

company predated and despatched interest warrants about a fortnight ahead of their due

date to prevent any inconvenience to its depositors. In another often-quoted instance,

many years ago when a middle-aged widow complained that she would have to bear

costly legal expenses to be able to withdraw her late husband’s deposit with the company,

the management decided to not only foot her bill but to henceforth provide all legal

documentation and help for transfer of an account of a late depositor to his or her heirs.

The company is also known to automatically offer the option of renewing existing

deposits at higher interest rates when sudden and sharp increases in deposit rates take

place.

“Everyone has discovered how important customer satisfaction is in recent years. We

started on the basis that customers are our friends. We are not moneylenders. We stand

by (our customers) during good times and bad times; and they will stand by us when we

need them.”

- T.S. Santhanam, Founder and Chairman SFL3

Helping the company provide good customer service was the culture of the company. The

company’s top management believed that shareholders would be benefited only if other


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stakeholders of the company are benefited at the same time. The TVS group, and SFL in

particular, were known to be model employers and this was reflected in the low turnover

of employees from the company.

SFL has to take very few steps to actively market its deposit schemes. In fact, for many

years, SFL was the only NBFC to refuse to pay “brokerage” which was actually a

euphemism for an upfront commission for deposit mobilisation. One estimate suggests

that as many as 90% of deposits in SFL are unsolicited and get automatically renewed.

The renewal rate exceeds 80% even for short one-year deposits. The average size of

deposits is Rs.10,000 and the number of depositors exceeds 420,000. Even in times of

recession and falling interest rates, SFL has had little difficulty in raising deposits. This is

reflected in the net accretion of deposits exceeding Rs.100 crores per annum in recent

years.

Equally important to SFL’s success is its choice of targets for its lending activities. While

its original choice of small truck operators was driven by the fact that these operators

were being exploited by moneylenders and did not have other sources of finance, over the

years SFL has found that this is an ideal group to lend to. Unlike big fleet operators who

often enjoy political patronage and are difficult to control, small operators who own one

or two vehicles each have proved to be reliable in meeting their debt obligations. The key

is to evaluate the operator’s creditworthiness effectively. The company has managed to

hone its expertise in this area over the many years of its operation and keeps a close tab

on about 38,000 individual loan accounts of an average size of Rs.2,40,000 which


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support a vehicle population of over 40,000. SFL has managed to maintain a high loan

recovery rate of 97.97%. As of March 31, 1995, overdues amounted to only 1.2% of

stock-on-hire, the lowest in the industry and non-performing assets were a reasonable

0.7% of all business assets.

To avoid bad debts, SFL takes special steps to know its customers. The backbone of this

is its “personalised intelligence network.” It has a network of 80 branches (1995), a

lending operations staff of 500 people and a field collection staff of about 250. The

original branch network covering the southern states of India was expanded into strategic

locations in the north and west from around 1985. Reflecting this expansion, the number

of branches grew from 36 in 1985 to 65 in 1990, and to 80 in 1995.

Each client is contacted, on the average, once in ten days and a personal relationship is

established with company staff. There is one field staff for every 300-400 clients. Many

of the company’s branch managers are important social figures and opinion leaders in

their communities. Their local standing enables them to continuously monitor the

financial status of each borrower - his ability as well as willingness to pay. This network

is key to ensuring effective credit rating of thousands of small, dispersed and unorganised

truck operators, many of whom do not even maintain proper books of account. This

ultimately leads to timely recoveries, early warning and control of problem accounts and

consistently high asset quality over long periods of time.


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“This is a specialised field. We know our customers personally. Our credit appraisals are

based sometimes on knowing two or three generations of a customer’s family and not on

ratings and bank guarantees”

- G.K. Raman, Managing Director, SFL.4

The average tenure of deposits and renewals is two years which matches the average hire

purchase lending period of 2.5 years quite well thus avoiding a serious mismatch between

deposits and receivables.

Competition

In seeking deposits from the investing public, SFL competed with a whole range of

alternate instruments offered by the government, banks, financial institutions, mutual

funds, and other NBFC's apart from unincorporated finance companies, mutual benefit

funds and local financiers in the unorganised sector. Exhibit 5 depicts distribution of

household savings among various financial instruments.


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Government securities, banks and financial institutions:

While the interest rates offered by government securities were much lower, they offered

the safety of the sovereign guarantee. Government securities were however considered to

be highly illiquid. Deposit schemes of banks (most of which were wholly owned by the

government of India) and government owned or controlled financial institutions offered

higher interest rates than government securities. While public sector banks had limited

retailing strength, in the 1990s the financial institutions were getting more aggressive in

the retail market with a network of agents and sub-agents and extensive advertising in the

print media and television. Household bank deposits were estimated at Rs. 35,284 crores

as of 1995-96.

Other NBFC’s:

In 1996, there were an estimated 40,000 NBFC's in India, though only 4,000 of these

were believed to be active. These NBFC's had been created in two waves – the first one

of leasing companies in the early 1980s, and the second one prompted by the ease in

accessing the equity markets in the early 1990s. The NBFC’s depended on equity capital,

finance from banks and deposits from investors to fund their activities, which included

bill discounting, leasing, hire-purchase and merchant and investment banking. Raising

money from banks was difficult because the banks felt that the NBFC’s were

competitors, there were RBI curbs on bank lending to NBFC’s and, in many cases, the

banks felt it imprudent to lend to NBFC’s. Several large and aggressive NBFC’s


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competed with SFL in the fixed deposit market. A profile of two leading NBFC’s –

Kotak Mahindra Finance Ltd. and Cholamandalam Investment and Finance Company

Ltd. is given below. Exhibit 6 compares SFL’s financial performance with these two

NBFC’s on the basis of some of the parameters used by CRISIL for credit rating.

Kotak Mahindra Finance Ltd (KMFL).:

Fixed Deposit Programme Rating FAAA (CRISIL)

KMF was formed in 1985 through a partnership between a young management graduate,

Uday Kotak, and the Mahindra group with a capital of Rs. 3 million. Its initial strategy

was “to capitalise on the imperfections of the Indian capital market” and to enter

relatively under-regulated areas like bill discounting. KMFL later diversified into leasing

and lease syndication of big-ticket leases. KMFL entered consumer finance through the

automobile finance market around 1990. In 1994-95, KMFL had a gross income of Rs.

246 crores and a net profit of Rs. 64 crores. By mid-1995, KMFL had announced its

decision to hive off its three major businesses – investment banking, consumer finance

and asset finance – as separate companies, to enter into joint ventures wherever

necessary, and to enter new areas like insurance, information services and mutual funds.

Cholamandalam Investment and Finance Company Ltd.:

Fixed Deposit Programme Rating FAAA (CRISIL)

Cholamandalam was promoted in 1978 by the Madras based Murugappa Group. The

Murugappa Group had a successful track record of managing medium sized companies in

diverse fields, and a conservative management style. Cholamandalam commenced


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leasing of plant and machinery in 1979 and subsequently ventured into hire purchase

financing of plant and machinery in 1982, and bills discounting in 1987. The company

grew fast between 1992 and 1995, with funds deployed registering a compounded annual

growth rate of 49% to reach Rs. 330 crores by June 1995. Cholamandalam’s main line of

business was hire purchase financing with the accent shifting to financing cars, LCV’s

and HCV’s. However, plant and machinery continued to enjoy a sizeable chunk of the

asset portfolio. Cholamandalam also does bill discounting with the average deployment

of funds at about Rs. 40 crores.

The Unorganised (& unregulated) sector:

This sector is vast and no accurate estimates exist of its size. It principally consists of

proprietorship or partnership firms which offer interest rates as much as 10 per cent more

than the NBFC’s. They are unregulated and play on the greed of investors. Their avenues

for lending are limited and many of these firms collapse after some time leaving investors

in the lurch. They nevertheless continue to attract interest among depositors and use

hoardings to announce their products and on-the-spot incentives to attract investors.

Mutual funds:

Mutual Funds (MF’s) are financial intermediaries which pool the savings of numerous

individuals and invest the money raised in a diversified portfolio of securities, including

equity, bonds, debentures and other instruments, thus spreading and reducing risk.

Individual investors receive units/shares of the MF for the amount they invest. Small


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investors are unable to buy blue chip shares, which trade at high prices. However, if these

investors purchase units/shares (at say Rs. 10 per unit) of an MF which acquires these

blue chip shares, they have an indirect equity stake in the blue chip firms. Also the small

investor rarely has the time or the knowledge to analyse the prospects of corporates,

unlike dedicated and qualified analysts at MF’s. Hence MF’s seem to be an easy and safe

route for the small investor to enter the stock market.

Mutual Funds differ from banks and banking companies in that banks provide transaction

services i.e. monetary liabilities which facilitate the exchange of goods and services by

transforming short term liabilities (deposits) into long term assets (loans). The MF’s do

not have fixed liabilities to pay, as interest or dividend on the holdings of the investors is

not guaranteed until expressly committed as such. They simply manage portfolios whose

values may increase or decrease and dividend is paid only if a surplus of income is made.

These funds have different schemes with growth, income or balanced funds as their

objectives. Exhibit 7 provides a description of several Mutual Fund Schemes.

The Mutual Funds Diversification Decision

Unlike many other NBFC’s, SFL did not move aggressively into new areas immediately

after the historic announcement of economic policy changes by the Indian government in

1991 and the gradual unfreezing of the financial services sector in the following year.

Instead it opted to move slowly, testing the waters with gradual investments.


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Sundaram Finance Services Ltd. was formed in 1991 to undertake merchant banking and

advisory services apart from other NBFC activities like bill discounting, leasing and hire

purchase. While the initial focus was on the former, by 1996 the latter had begun to

dominate. The company earned a gross income of Rs. 11.77 crores in 1995-96 and a

Profit after tax of Rs. 2.32 crores. The gross income consisted largely of income on bills

purchased (Rs. 7.55 crores) and lease income (Rs. 2.79 crores) while management and

other services contributed just Rs. 0.38 crores to the gross income figure.

Another subsidiary, Sundaram Finance Securities Ltd., was established in 1994-95 to

undertake stockbroking activities. In 1995-96, this company had a marginal profit against

an operational income of Rs. 0.18 crores.

In the light of these slow moves, analysts were surprised by the 1995 announcement that

SFL planned to set up a mutual fund.

Growth of Mutual Funds in India over the previous 10 years

The Indian Mutual Funds Industry recorded a tremendous growth in size with cumulative

resources mobilised rising from Rs. 4,564 crores in 1986 to over Rs. 81,000 crores in

1996.

The Indian mutual fund industry began with the formation of Unit Trust of India (UTI) in

1963. The first mutual fund was Unit Scheme '64, which is still the biggest scheme. The

UTI introduced several schemes aimed at different sections of people. The public sector


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monolith operated under monopoly conditions and in an over regulated economy till the

mid-eighties. In 1987, the commercial banks and the insurance companies were also

permitted to launch schemes. Their schemes were received with enthusiasm and more

than Rs.6,000 crores were raised in 1988-89. The mutual funds launched by subsidiaries

of nationalised banks sold their schemes like any other traditional banking deposit.

Assured returns were offered in some schemes and this might have created a perception

that mutual funds are as safe as nationalised bank deposits. The boom continued into the

nineties with the liberalisation evoking positive response from the investors and acting as

an additional catalyst for growth. In 1991-92 mutual funds mobilised a record Rs.14,000

crores.

The industry experienced its first setback after the stock market crash of 1992. The

annual gross mobilisations of the Mutual Funds fell to Rs.9,500 crores during the year. At

that point the market was further liberalised as foreign institutional investors were

permitted portfolio investments. The financial markets once again picked up. In addition,

the period also witnessed a tremendous growth in the primary markets with annual

mobilisations from equity issues crossing Rs.36,000 crores in 1994-95 (as against

Rs.18,100 crores raised in 1992-93). The resource mobilisations by Mutual Funds also

continued to remain high with annual gross mobilisation averaging Rs.14,000 crores per

annum during the period 1993-95. This phase also saw the entry of several private sector

mutual funds. However the crash in the financial markets in October 1994 and the

continued prevalence of bearish conditions hit mutual funds. During 1995-96, Mutual

Funds resource mobilisations (at around Rs.5,900 crores) were at a six year low.


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In spite of their evolution in developed economies as low-risk, medium return

investments, in India most mutual fund schemes are still seen as either substitutes for

equity or as substitutes for riskless fixed deposit bonds with regular interest payments. To

quote Mr. Basudeb Sen, General Manager (UTI), “A Mutual Fund is not a substitute for

equity. The investor needs to understand that he/she is taking an average risk, and

consequently, the returns are average”. Mr. Pratip Kar, Executive Director, SEBI

cautions “Mutual Funds are not free from risk. Afterall, the money is invested in the

stockmarket”.5

While in the US, as of 1995, there were over 7,000 Mutual Funds (equivalent to schemes

in India) with an aggregate corpus of over US $ 2300 Billion, India had just about 200

schemes with an aggregate corpus of Rs. 75,000 crores (approx. US $ 20 Billion). Exhibit

8 depicts the number and type of Mutual Fund Schemes in India as of October, 1994.

Policy on Private Mutual Fund Formation, Expenses and Remuneration

To spread the equity cult and provide greater stability and depth to the Indian capital

market, the government of India permitted the formation of mutual funds by the private

sector as part of its economic liberalisation package. While the mutual fund itself was to

be set up as a Trust under the Indian Trusts Act, the management of the fund is in the

hands of a separate Asset Management Company (AMC) in which the sponsors of the

fund have a minimum stake of 40%. The AMC has to be set up with a mandatory share


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capital of Rs. 5 crores. Joint stock companies with a five-year track record of profits were

allowed to sponsor mutual funds.

Mutual funds incur both pre-operational and recurring expenses. The former includes the

cost of the issue, advertisements, stationery charges, brokerage, commission to agents,

stamp duty and other marketing and administrative expenses. These are corpus linked.

The SEBI has issued a ceiling of 6% on these expenses. Therefore, if a MF gathers Rs.

100 crore from depositors through an issue, it is entitled to spend Rs. 6 crores on pre-

operational expenses. Often, the funds of the investors are depleted by the amount of such

expenses even prior to the issue.

SEBI permits recurring (annual) expenses which are calculated as a percentage of the

weekly net average assets. These expenses have a ceiling of 3%. These could include

AMC fund managers' remuneration (which is restricted to 1%), custodial fees and

registrar and share transfer agent fees.

The Mutual Fund Industry in 1996

The initial response to the policy initiative deregulating the formation of mutual funds

was very positive with almost a hundred applications received within a year. Among

these were leading Indian industrial groups like the Tatas, Reliance, Essar and financial

companies like KMFL and DSP Financial Consultants. The early interest in mutual funds

coincided with the bull run on the Bombay Stock Exchange that continued until the

Securities Scam of 1994.


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Mutual funds were becoming increasingly popular among middle class Indian investors

in the early 1990s. Some of the trends noted in a study conducted in 19936 are presented

in Exhibits 9, 10, 11 and 12. The study found that over 57% of the investors preferred

monthly income schemes. It also revealed that over 97 per cent of Mutual Fund investors

are individuals while less than 1 per cent comprise corporate and trust investors.

However, the corporates and trusts invested over 26 percent of the total funds, while the

contribution of individuals was a little over 70 per cent.

By 1995, however, the Indian mutual fund industry hit a bad patch. The Chief Investment

Officer of Alliance Capital, one of the leading players, told a business magazine in

January 1996 that “the only good thing about 1995 is that it is finally over.”7 This was an

interesting denouement for an industry, which started with bright expectations.

In the first half of 1995-96,

• 23 schemes of the private mutual funds posted a net loss of Rs. 276 crores on a unit

capital of Rs. 2,840 crores;

• Only seven of the 23 reported profits;

• At least six new funds delayed the launch of their schemes;

• The UTI, the largest fund with 83% of the investible funds in the industry, had a net

outflow of Rs. 347 crores during the year;


25

• Most funds had to cut their targets (e.g. Tata Mutual Fund from Rs. 500 crores to Rs.

100 crores), and the total funds collected by the private mutual funds was Rs. 600

crores against Rs. 900 crores in the previous year.

Investor confidence in mutual funds had declined because of the steady decline in the Net

Asset Value (NAV∗) of the existing funds. While in 1994 investors tended to compare

returns on mutual funds to the easy pickings available through investments in Initial

Public Offers of stock, in 1995 it was the turn of debt to outperform mutual funds. About

47% of all household savings in India were in fixed deposits against 7.6% in mutual

funds in 1994-95. Exhibits 13 and 14 show the cumulative resources raised by both

public and private sector mutual funds in India as of March, 1996.

In spite of the problems it faced, many industry leaders were positive about the future:-

“The sheer experience (bad) of direct investment will eventually turn people to Mutual

Funds since risk diversification becomes a pre-requisite” – K.N. Vaidyanathan, Country

Manager, Morgan Stanley Asset management India Pvt. Ltd.

∗ NAV is the parameter used to rate the performance of MF’s on a daily basis. In simplistic terms, it is calculated as the total worth of all the investments of a MF divided by the number of outstanding units/shares. NAV is equivalent to the market price of an open ended MF unit/share. Actual calculations involve adding to the total market value of a MF’s assets the following: (i) Receivables, (ii) Accrued income, (iii) Other assets; and deducting the following: (i) Accrued expenses, (ii) Payables, (iii) Other net liabilities. The net figure obtained is divided by the number of outstanding units/shares to give NAV.


26

“Often investors compare units with those available in the primary market and expect a

high listing price. They don’t realise that it is a low risk, long term instrument that offers

steady returns” – Vivek Reddy, CEO, ITI Pioneer.

“Mutual Funds are only for those who have the patience to wait for three to five years” –

M.M. Khurana, General Manager, SBI Mutual Fund.

“With the capital markets getting more sophisticated and better regulated, and with large

household savings still in traditional bank deposits, mutual funds have a huge potential.

Once portfolio disclosure becomes transparent and NAV’s are declared daily, investor

confidence will re-emerge.” – Sanjay Jha – Vice President, Alliance Capital.

The Decision

Analysts wondered why SFL was interested in starting a mutual fund in such adverse

market conditions. In contrast, the Board of Directors of SFL, referring to the growth in

sales of commercial vehicles of 24% during the year, looked forward to “registering a

reasonable growth in hire purchase and leasing business by adopting suitable funding and

business strategies”.8 In the long term, the demand for road transportation of goods in

India was poised to grow substantially with a higher degree of industrialisation, growing

urbanisation and higher standards of living. By 2000 AD, truck sales were expected to

double to over 3,50,000 vehicles a year from about 1,70,000 in the year 1994-95.


27

Of greater concern was the impact selling mutual fund units to investors would have on

the company’s existing investor base. Would SFL’s small investors be able to understand

the difference between a fixed deposit and an investment in SFL’s mutual fund? In the

event of a continuing downturn and an NAV below par, would SFL’s reputation with

investors be affected? What benefit would SFL get from the mutual fund as its earnings

would be limited to its share in the profits of the Asset Management Company? These

were some of the questions troubling the analysts as SFL seemed on the verge of

announcing the launch of its new mutual fund.


28

EXHIBITS Exhibit 1: Category-wise number of NBFC schemes with net owned funds over Rs. 5 million (as of September 30, 1995). Source: “Non-Banking Finance Companies”, Banking Finance, July 1997. Scheme Category Number Hire Purchase 169 Loan 300 Investment 597 Equipment Leasing 71 Nidhis and Chit Funds 8 Others 4 Total 1147 Exhibit 2: Summary of SFL’s financial performance over the years since inception. Source: Company Annual Report 1995-96, p.11). All figures in Rs. Crores.

YEAR PAID-UP CAPITAL

RESERVES DEPOSITS STOCK-ON HIRE

LEASE RECEIVABLES

PBDT PROFIT AFTER TAXES

DIVIDEND %

1955 0.07 - 0.20 0.57 - 0.01 0.01 5.00 1965 0.60 0.31 1.73 5.58 - 0.39 0.14 14.00 1975 1.00 1.08 11.76 21.40 - 1.16 0.4 16.00 1980 2.00 2.26 26.28 47.14 - 2.48 0.91 20.00 1985 3.00 7.84 86.49 118.62 32.13 8.53 2.74 20.00 1986 6.00 6.59 104.10 135.47 49.19 10.35 2.67 16.00

Jan-Mar'87 6.00 8.00 108.39 143.94 63.98 3.1 1.15 4.00 1987-88 6.00 15.08 127.93 153.42 75.08 15.56 4.68 20.00 1988-89 6.00 19.83 144.16 200.02 80.38 19.17 6.56 30.00 1989-90 6.00 27.23 167.64 278.47 85.06 25.13 9.2 30.00 1990-91 12.00 30.24 201.02 380.87 102.34 34.69 12.01 25.00 1991-92 12.00 53.40 226.03 435.11 128.63 49.56 26.91 30.00 1992-93 12.00 79.02 262.83 554.27 169.12 62.51 29.83 35.00 1993-94 12.00 115.34 351.69 714.85 239.84 85.16 41.71 45.00 1994-95 12.00 159.79 431.03 920.59 295.57 103.21 50.47 50.00 1995-96 24.00 204.31 550.44 1209.64 427.41 127.50 64.92 35.00


29

Exhibit 3: SFL Balance Sheet for the years 1995 and 1996 (as of March 31). All figures in Rs. Crores (Source: Company Annual Report 1995-96, p. 12) March 31, 1996 March 31, 1995 SOURCES F FUNDS 1. Shareholders’ Funds

(a) Capital 24.00 12.00 (b) Reserves & Surplus 204.31 159.79

228.31 171.79 2. Loan Funds

(a) Secured Loans 542.02 486.95 (b) Unsecured Loans 596.66 439.18

1,138.68 926.13

TOTAL 1,366.99 1,097.92 APPLICATION OF FUNDS 1. Fixed Assets

(a) Gross Block 469.83 333.40 (b) Less Depreciation (209.49) (163.01) 260.34 170.39 (c) Add: Lease adjustment account 66.79 52.61 (d.) Net Block 327.13 223.00

2. Investments 110.69 97.15 3. Current Assets, Loans & Advances

(a) Current Assets 1,255.35 987.62 (b) Loans & Advances 145.36 143.74

[A] 1,400.71 1,131.36 LESS: Current Liabilities and Provisions (a) Current Liabilities 460.23 339.79 (b) Provisions 11.31 13.80

[B] 471.54 353.59 4. Net Current Assets (A-B) 929.18 830.38

TOTAL 1,366.99 1,097.92


30

Exhibit 4: Profit and Loss Account for the years ending March 31, 1995 and 1996. All figures in Rs. Crores. (Source: Company Annual Report, 1995-96, p. 13). 31/3/96 31/3/95 Income Income from Financing Operations 310.82 232.88 Other Income 22.47 17.60

(A) 333.29 250.48 Expenditure Financial Expenses 176.97 122.08 Establishment Charges 9.16 7.18 Administrative and Other Expenses 19.66 18.01

(B) 205.79 147.27 Profit before Depreciation and Tax (A-B) 127.50 103.21 Less: Depreciation 56.76 45.23

Profit before tax and lease equalization account 70.74 57.98 Add/(Less): Lease equalisation account 14.18 16.07

Profit before tax 84.92 74.05 Less: Provision for taxation 20.00 23.60

Profit after tax 64.92 50.45 Add: Investment Allowance Reserve withdrawn - 0.02 Add: Balance brought forward from previous year 2.25 2.78 Amount Available for Appropriation 67.17 53.25 Appropriations Dividend 8.40 6.00 General Reserve 57.00 45.00 Surplus – Balance carried to Balance Sheet 1.77 2.25


31

Exhibit 5: Instrument-wise annual distribution of Household Assets in crores of rupees. (Figures in brackets indicate percentage of total). Source: RBI, Currency and Finance 1995-96 (Vol. 11). 1980-81 1990-91 1992-93 1993-94 1994-95 1995-96 1 Gross Savings 12,117 59,967 80,453 1,09,562 1,39,778 1,24,793 2 Currency 1,625

(13.4) 6,251 (10.6)

6,562 (8.2)

13,367 (12.2)

15,916 (11.4)

16,375 (13.1)

3 Bank Deposits 5,550 (45.8)

18,777 (31.8)

29,550 (36.7)

36,378 (33.2)

56,164 (40.2)

35,284 (28.2)

4 Non-bank Deposits

378 (3.1)

1,286 (2.2)

6,035 (7.5)

11,654 (10.6)

11,743 (8.4)

17,079 (13.7)

5 Life Insurance Funds

915 (7.6)

5,599 (9.5)

7,114 (8.8)

9,548 (8.7)

11,344 (8.1)

13,481 (10.8)

6 Provident and Pension Funds

2,122 (17.5)

11,155 (18.9)

14,817 (18.4)

18,248 (16.7)

20,619 (14.8)

25,438 (20.4)

7 Claims on Govt. 712 (5.9)

7,942 (13.5)

3,949 (4.9)

6,784 (6.2)

13,222 (9.5)

10,873 (8.7)

8 Shares and Debentures

412 (3.4)

4,972 (8.4)

8,212 (10.2)

10,067 (9.2)

8,461 (6.1)

5,880 (4.7)

9 UTI Units 31 (0.3)

3,348 (5.8)

5,612 (7.0)

4,705 (4.3)

3,908 (2.8)

262 (0.2)

10 Trade Debt 373 (3.1)

-453 (-0.8)

-1,398 (-1.7)

-1,190 (-1.1)

-1,600 (-1.1)

300 (0.2)


32

Exhibit 6: Comparison of three top ranking NBFC’s for the financial year 1994-95. All figures in Rs. Crores. (Source: CRISIL Rating Scan, April 1996, p. 50 for SFL and July 1996 p. 40 for KMFL and p. 62 for Cholamandalam).

Company SFL KMFL Cholamandalam 3/95 3/94 3/95 3/94 6/95 6/94 Equity Share Capital 12.00 12.00 36.73 18.31 16.82 8.50 Networth 171.79 127.34 249.00 188.04 105.84 31.79 Net Stock on Hire 675.54 510.94 481.42 166.70 94.76 68.89 Gross Leased Assets 316.80 250.78 347.01 230.38 112.19 70.02 Net Leased Assets 212.88 173.24 268.78 171.46 74.72 42.79 Hire Purchase Income 150.46 119.07 52.39 17.02 25.26 16.08 Lease Income 68.76 56.00 74.76 48.06 25.25 17.70 PBT (Reported) 57.98 47.65 68.20 47.29 17.94 9.72 PAT (Reported) 34.38 26.65 64.20 42.29 16.19 8.52 Dividend/PAT (%) (Reported) 17.5 20.30 6.10 7.40 28.10 34.90 Dividend Rate (%) 50.00 45.00 18.00 18.00 40.00 35.00 Expenses/Assets Deployed (%) 1.90 1.80 2.80 - 1.80 2.40 Total Debt/Networth (Times) 5.40 5.20 3.90 2.20 1.90 4.50

Exhibit 7: Mutual Fund Schemes. Source: “Mastering Mutual Funds’, C.M. Kulshreshta. Published by Vision Books Pvt. Ltd., 1994. Schemes floated by various Mutual Funds are essentially of two types, namely Open Ended and Close Ended. From the point of view of investment objectives, these may be further divided into Income, Growth, Balanced (Income + Growth) or Tax Saving Schemes. Open Ended Schemes: These are available for subscription all the year round excluding the period of book-closure. They may or may not have a specified redemption period. For instance, UTI’s Unit 64 Scheme has no prescribed time limit when it would be redeemed. The sale and repurchase prices are fixed by the mutual fund concerned from time to time. Repurchases are generally allowed at specified rates. Close Ended Schemes: These are open for subscription only during a specified period. Generally, the redemption is also specifies, and this means that they terminate on certain specific dates when the investors can redeem their units. The duration of the scheme may vary – normally it is 5-7 years. Repurchase during the intervening period may or may not be allowed. UTI’s Monthly Income Scheme is an example of a Close Ended Scheme. Income Schemes: These provide returns in the form of dividends. The returns may be cumulative or non-cumulative on a monthly, quarterly, half-yearly or yearly basis. Since Mutual funds carry market risks, they are prohibited from declaring any guaranteed rate of return. (UTI’s


33

Monthly Income Scheme is an exception). In view of the regular and steady flow of returns required by investors, the corpus is invested predominantly in fixed income securities, like debentures, bonds, government securities, while a relatively lower percentage is invested in equity shares. Growth Schemes: These are usually close ended. The aim of such schemes is to provide capital appreciation to their investors and accordingly, a substantial part of the corpus is invested in equities and convertible debentures. Such schemes are usually listed on the major stock exchanges and the capital appreciation is reflected in their market quotations. They may or may not declare dividends. However, the declaration of annual dividends signals to investors that the scheme is healthy. UTI’s Mastershare 86 is an example of a growth scheme. Income + Growth Schemes or “Balanced Schemes”: The aim of such schemes is to provide both steady income as well as capital appreciation. Therefore, the investment is divided almost equally between debt and equity. For instance, the Centurion Prudence Fund 93 was an income + growth (balanced) scheme floated by 20th Century Mutual Fund with the declared objective of providing stable and periodic returns, and maximizing the total returns (dividend + capital gain) to investors had the following composition: Equity: 30% Equity related instruments: 15% Debt instruments: 50% Money market instruments 5% Equity Linked Savings Schemes (ELSS) or Tax Savings Schemes: These are essentially close-ended growth schemes floated by almost all the public sector mutual funds in the last quarter of each financial year. They provide tax rebates to the extent of 20-25% upto a ceiling of Rs. 10,000. Their duration is generally 10 years, but repurchases are allowed after a specified period – usually 3 years.


34

Exhibit 8: Mutual Fund Industry in 1994. Source: “Mutual Funds – Future Shock”, Business India October 24-November 6, 1994, p. 54. (Size of assets Rs. 70,000 crores) Number of Players 14 Number of Schemes 142 Close Ended schemes 130 Open Ended schemes 12 Growth schemes 38 Tax saving schemes 37 Income schemes 28 Balance schemes 34 Others 4 Exhibit 9: Source – “Mutual Funds and Asset Preference”, L.C. Gupta. Published by Society for Capital Market Research and Development, 1993.

UTI Units: Ownership incidence among household investors by

income class

31

45

70.5 75.1

56.5

40.427.6

17.9

01020304050607080

Upto2500

2501-5000

5001-10,000

Over10,000

Income Class (Rs. per month)

Per

cen

t o

f h

ou

seh

old

s o

wn

ing

th

e as

set

1990-911992-93


35

Exhibit 10: Source – “Mutual Funds and Asset Preference”, L.C. Gupta. Published by Society for Capital Market Research and Development, 1993

Exhibit 11: Source – “Mutual Funds and Asset Preference”, L.C. Gupta. Published by Society for Capital Market Research and Development, 1993

New Mutual Funds: Ownership incidence among household investors

by income class

30.420.7

10.35.415.1

29.5

45.1

65.7

010203040506070

Upto2500

2501-5000

5001-10,000

Over10,000

Income Class (Rs. per month)

Per

cen

t o

f h

ou

seh

old

s o

wn

ing

th

e as

set

1990-911992-93

Per cent of each age class of household investors holding UTI and

New MF assets (1993)

40.4 42.9

59.1 59.7 60.8

73.6

34 29.638.2 43.4 40.7 41.6

01020304050607080

Upto25

26-30

31-40

41-50

51-60

Over60

Age-Group in years

Per

cen

tag

e o

f H

old

ers

UTI UnitsNew MF's


36

Exhibit 12: Occupational Classification of Mutual Fund Investors in India (1993). Source –“ Mutual Funds in India – Marketing Strategies and Investment Practice”, H. Sadhak. Published by Response Books, 1997. (Note: This data is limited by the exclusion of “pure” growth schemes. However, tax saving schemes may be taken as a proxy for growth schemes as they have no investment restrictions and invest about 80% of funds in equity related instruments.)

TYPE OF SCHEME Income Income+Growth Tax-Saving Overall

Occupation

No. (%)

Amt. (%)

No. (%)

Amt. (%)

No. (%)

Amt. (%)

No. (%)

Amt. (%)

Professionals 4.24 4.06 6.03 6.03 6.49 6.90 5.18 4.81 Service 20.17 14.11 25.37 18.45 51.5 45.04 32.43 21.63 Business 17.14 14.72 19.41 18.23 22.87 27.99 19.44 18.01 Agriculture 2.62 2.47 3.56 4.37 0.30 0.35 1.77 2.04 Housewives 22.43 20.71 21.18 20.66 3.15 3.56 14.98 16.64 Other 33.4 43.93 24.45 32.26 15.69 16.16 16.20 31.87


37

Exhibit 13: Cumulative Resources raised by various Indian Mutual Funds in crores of rupees as of 1996. Source: Securities & Exchange Board of India, Annual Report 1995-96. No. Mutual Fund Income

Schemes Growth Schemes

Income & Growth Schemes

Tax Saving Schemes

Venture Capital Schemes

Total

1 UTI 25,970 8,625 29,622 3,063 212 67,492 2 Canbank 353 1701 709 2,764 3 SBI 458 1,528 200 577 2,763 4 LIC 754 338 195 222 1510 5 GIC 54 504 721 102 1381 6 Morgan Stanley 982 982 7 BOI 110 576 37 722 8 Indbank 93 228 252 66 638 9 PNB 64 202 156 422 10 Kothari Pioneer 93 105 130 328 11 Taurus 304 304 12 ICICI 249 249 13 CRB 229 48 229 14 Birla 56 162 218 15 IDBI 150 60 210 16 JM 46 98 1 193 17 20th Century 36 133 1 170 18 Apple 108 108 19 Tata 93 12 105 20 Reliance 74 74 21 Alliance 71 2 73 22 Shriram 20 21 41 23 BOB 41 41 24 Jardine Fleming 5 5 Total 27,640 14,919 33,046 5,209 212 81,027


38

Exhibit 14: Growth of Cumulative Resources mobilized by Indian Mutual Funds in crores of Rupees. (Source: Securities & Exchange Board of India: Mutual Funds 2000 Report and Annual Report 1995-96). Year UTI Other Public

Sector MF’s Private Sector

MF’s Total

1986-87 4,564 4,564 1987-88 6,739 6,739 1988-89 11,835 1,621 13,456 1989-90 17,651 1,460 19,111 1990-91 21,376 1,684 23,060 1991-92 31,806 5,675 37,480 1992-93 38,977 8,011 46,988 1993-94 51,978 8,407 916 61,301 1994-95 61,500 10,550 3,000 75,050 1995-96 67,492 10,451 3,083 81,026


39

References 1 From S. Venkitaramanan “Non-bank Finance” Banking Finance June 1997, pp. 33-34. 2 This section draws on an article titled “Case Study: Sundaram Finance” in FT India Business Intelligence, Issue No. 40, July 12, 1995, published at London. 3 “Changing with the times” Business India December 16-29, 1996, p. 92 4 “Changing with the times” Business India December 16-29, 1996, p. 92 5 Business India October 24-November 6, 1994, p. 57 6 L.C. Gupta Mutual Funds and Asset Preference New Delhi: Society for Capital Market Research and Development, 1993. 7 “Mutual Mistrust” Business India January 1-14, 1996, pp. 70-71. 8 From Directors’ Report in 1995-96 Annual Report

Case Analysis -3

Documents

cumulative resources raised

indian mutual funds

capital market research

indian capital market

sfls financial performance

net owned funds

equity related instruments

mutual fund industry