A foreign brand counts for little in the Indian asset-management industry, where global names are often unheard of -- and last year's ban on front-end fees for mutual funds won't make things any easier for overseas firms, says US research house Cerulli Associates

The most likely way for a foreign firm to thrive in the onshore Indian market is to tie up with a well-known partner, preferably a bank, says Cerulli in the March edition of its emerging-markets issue, released last week. Domestic asset managers and foreign managers in largely Indian joint ventures have performed best in the country in terms of asset base, revenues and profitability, says the report. (One exception is Franklin Templeton, which has operated in India since 1996 and has been highly profitable.)

However, the choice of distribution partners is limited to state-run banks, since all the local private-sector banks are already in the asset-management business or currently obtaining approvals from the Securities and Exchange Board of India (Sebi).

Cerulli's findings emerged from a study of 22 of the 36 asset managers in India. It concludes that in 2009, revenues from operations as a percentage of average assets under management were 57.1 basis points and operating expenses as a percentage of average AUM were 46bp. Operating profits for all the 22 managers put together stood at 10.5bp.

Moreover, Sebi's move to ban front-end fees for all mutual funds from August 1 last year has made things even more difficult for foreign managers without onshore partners. That's because asset managers that use a third-party distribution system must now persuade distributors to sell their funds through incentives, which are "almost certain" to have a big impact on their balance sheets, says Cerulli. Those managers now have to pass a higher percentage of their revenues to distributors as incentives for fund sales.

The growing bargaining power of distributors will prompt asset managers to reconsider their reliance on a third-party sales network, says the report. This means the bigger players, with their own distributors, will be at a distinct advantage. The top-five domestic asset managers have proprietary distribution arms, and of the seven foreign managers in predominantly Indian JVs, four have domestic banks as local partners and the other three have onshore distributors under the parent group.

A few asset managers are likely to set up their own distribution arms, says Cerulli, but doing so will require significant capital investment -- which only the most serious and largest managers will be able to pursue.

(The aim of Sebi's ban on front loading was to transform a model where distributors push products to one where people have the information and wherewithal to buy whatever funds they want, via a bank or adviser, directly online or on a stock exchange. But market participants point out that since distributors no longer receive upfront fees for mutual fund sales nor can they bury client fees into the sale of a fund, they have simply stopped selling them and have switched to pushing unit-linked investment products.)

As for the kind of approach that will prosper in the new environment, Cerulli says that having a "judicious mix of assets that are profitable" is more important for a fund manager in India than an asset base composed largely of money-market and fixed-income funds. But few have increased their proportion of equity assets beyond the industry average of 27%, apart from a handful of firms -- such as DSP BlackRock, Sundaram BNP Paribas and Fidelity -- whose equity assets make up more than half their assets.

Nor have many managers entered the portfolio-management services (PMS) business, and even for those that have, PMS contributes only a small proportion of their revenues, says Cerulli. Yet PMS products yield higher fees than mutual funds and could provide a profitable income stream.

Ultimately, few managers will be able to withstand the pressures of the ban on front-end fees and cope with the increasing industry competition, argues the report. Moreover, if Sebi decides to increase the required minimum net worth of a mutual-fund firm from the current Rs100 million ($2.2 million), many smaller players will sell out.

For an in-depth look at India's funds industry, see the March issue of AsianInvestor.