Motilal Oswal Case Study in Switzerland financial magazine - Sep 2016

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Vol. V
N°56 - Septembre 2016
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Vol. V - N° 56 - Septembre 2016
1
L’AVIS DE L’ANALYSTE
Motilal Oswal: Transforming the business model amid turbulent times, to build 4 en-
gines of long-term sustainable Return on Equity
In FY2013-14,the capital market focused firm
found itself at a critical juncture
Established in 1987 by two first-generation entrepreneurs,
Motilal Oswal Financial Services Ltd’s (the firm)
distinctive positioning of using research and advice in
Indian equities helped it grow into one of India’s largest
stockbrokers. It was one of the few Indian brokers to have
meaningful presence in both, with healthy market share
across retail and institutional clients. Apart from its direct
branches, it also leveraged the power of entrepreneurship
using franchisee-partners to expand its retail network
across India. It was one of the first Indian brokers to gain
market share from both foreign and domestic institutions.
During the market cycle from FY2003 to FY2008, this
broking business alone had helped the firm’s profits grow
10X, along with a 3X growth in market share. Since 2003,
it extended this competence in equity research to active-
investing, through its managed accounts business (PMS).
Inspired by the likes of Warren Buffett and Benjamin
Graham, its investing philosophy was built on buy-and-
hold value-investing.
During 2007, the firm diversified its business mix
around this core. It expanded into related businesses like
investment banking, wealth management, private equity
and exchange-traded funds (ETFs). Each of these was
focused on specific differentiators. The ETFs provided
innovative market-access strategies. Private equity funds
invested growth capital into SMEs across consumption-
driven sectors. The real estate funds targeted upcoming
residential projects in Indian metros. Investment banking
focused on advisory, almost like a strategic CFO to the
client. In this process, the period from 2007 to 2012 was
an investment phase as the new businesses established
their right-to-participate. The original broking business
maintained stable profit margins despite the market cycle,
since its well-entrenched franchisee business helped keep
the cost-structure variable. By the end of FY2013,the firm
managed ~Rs 110 bn in depositary assets and ~Rs 30 bn
across its PMS, ETFs, private equity and real estate funds.
The wealth management business managed ~Rs 20 bn of
assets.
This phase from 2008 to 2013 saw a continued economic
slowdown in India due to various global and domestic
factors. The allocation of retail savers to equities, directly
or through mutual funds, remained volatile. This situation
impacted asset mobilization, volumes and revenue for the
firm. At the same time,the firm was also facing an internal
tribulation – that of low Return on Equity (RoE). Getting
the business right was one thing, but getting the allocation
of capital right was another! The firm’s capital market
businesses were essentially agency-driven, i.e. they hardly
needed huge capital. Since the broking business was cash-
flow positive, its internal accruals were more than adequate
to meet the need of the other businesses. So while these
agency businesses could earn as much as ~30% RoE, they
used up only Rs ~1-1.5 billion out of the firm’s Rs ~12
billion net worth in those times. Rs ~3 billion was also
invested in the new corporate tower in Mumbai, which
had its internal benefits of synergies by consolidating all
the businesses under one-roof. The firm had allocated Rs
~5 billion to its loan against shares lending book and Rs
~2-3 billion to a cash-futures arbitrage book. But once
intermediation costs and taxes were removed from their
returns, the net returns of ~9-10% and ~7-8% respectively
from these activities hardly justified the capital invested.
Once all the components were aggregated, the ROE for
the firm was sub-10%. Hence, the concern was to allocate
the net worth so that the firm, as a whole, could earn a
meaningful ROE? Moreover, as the profits added to the
net worth each year, even more net worth was becoming
ROE-dilutive!
Sourajit AIYER
AVP – Investor Relations &
Corporate Planning
Motilal Oswal Financial
Services Ltd
Sameer KAMATH
Group CFO
Motilal Oswal Financial
Services Ltd

2
One way to firm up the ROE was to return excess capital
to the investors. In line with its philosophy inspired by
Buffett, the firm had consistently paid dividends. It also
did a share buy-back programme. However, there was
a limit till which it could reduce its balance sheet. A
sizable balance sheet was a compulsion to give comfort
to institutional clients and banks. Maintaining a large
balance sheet became a necessary evil, the price for which
the firm paid through a lower ROE.
At this time,the firm found itself at a critical juncture,both
in terms of its business strategy and in capital deployment.
Bringing in a transformation in its business
model: From 2014 onwards
“To finish first, you have to first finish”
Inspired by this philosophy of Charlie Munger, the
promoters held the belief that it was better to concentrate
on fewer things, but do them so well that one could claim
to be a market leader in that space; rather than do too many
things where it did not have a right to win and would end
up being another me-too provider. In a market where the
competitive intensity was high,any company which did not
have a distinctive value-proposition could not go deeper
and risked losing brand recall. A differentiating value-
proposition gave clients a solid reason to come to you instead
of others, and gave the firm competitive advantages to
sustain market share for the long-term. If the business could
not offer a distinct promise to its customers to differentiate
itself from the crowd, it was better to exit rather than burn
capital. Differentiation also had to combine with efficient
processes and delivery to the customer. This combination
competitiveness and efficiencies would help build scale,and
cement the firm’s position for the long-term. This formed
the basis of the transformation of its business model, to
gear the firm towards earning a sustainable 20%+ ROE
over the long-term.
1stengineofROEgrowth:Areturntoitscorecompetence
of active-investing through new mutual fund products
As FY2014 ended,the leadership deliberated what was the
firm best known for? Equity research and active-investing
was the firm’s core competence. It had started from
advisory in broking and extended to active management
in PMS. The long term track-record of the flagship PMS
schemes stood testimonial to the firm’s prowess in active-
investing.
While its asset management business had launched ETF
products and seen healthy mobilization in their new-offer
period, subsequent sales in ETF products were yet to pick
in the Indian market. The fee-for-advice segment, which
majorly invested in index-based ETFs through asset
allocation strategies, was still not deep in India. So while
the ETFs provided innovative market-access, scaling up
the AUM base was a challenge with only ETFs.
Using its active-investing skills based on buy-and-hold
value investing, the firm now launched new open-ended
equity mutual funds. These were focused products on the
market-cap spectrum – just three funds based on large,
mid and multi market caps. It aimed to identify long-term
multi-baggers in a concentrated portfolio, to enable long-
term wealth creation for its customers. The firm’s investing
philosophy was documented as the QGLP framework. This
QGLP framework was the result of the series of Annual
Wealth Creation Studies which it had conducted each year
since 1996. It signified the methodology by which the firm
identified long-term multi-baggers - Q stood for quality
of the business and management, G stood for growth in
the business and sector, L stood for longevity, in terms of
sustainable competitive advantages the business had built
to sustain its business for the long-term, and P stood for a
reasonable price.
Very few asset managers in the Indian industry had
actually documented their investing process. Most asset
managers concentrate on performance, not on process.
But the firm wanted to sell its investing process, rather
than performance; since the performance was an output of
this well-crafted investing process.
In order to position itself as a niche equity specialists based
on its core competence of equities research and investing,
the firm’s gold and gilt funds were wound up. Having
products across asset classes made asset managers feel safe
in market cycles. But “me-too” products hardly succeeded
in incremental asset mobilization, when the crunch time
came. On the other hand, the firm’s core competence in
Indian equities served it well to scale up in that niche space.
The focus on its core competence meant that it invested
into a quality investing team rather than a large sales team,
and instead used external distributors to sell its funds.
Using the Dream Buyers concept from Chet Holmes’book
“Ultimate Sales Machine”, it identified a target list of key
distributors and started showcasing its QGLP process.
It conducted continuous engagement through seminars

3
to convey the QGLP philosophy. In a market where
most large asset managers were backed by large banks/
conglomerates, the pitch of its QGLP philosophy became
its right-to-win.
The last two years have seen the firm increase its market
share in net mobilizations in equity funds, which is proof
that it has been able to open the doors of several distributors
to its new equity funds by pitching its QGLP investing
process. Its net sales market share has been strong even
when the net flows in the overall market dipped. In the
process, it has emerged as one of the fastest growing equity
asset managers in India in the last two years,and has grown
its equity AUM ranking from #18 in Mar 2014 to #12 in
Mar 2016.
Not only do these fund products bring in annuity-income
which gives stability to counter the inherent cyclical
broking business, but they also bring in lumpy returns
through carry-income on exits from private equity funds
or performance fees in the PMS business. The first of
its private equity funds has seen exits from some of its
holdings at healthy multiples, and this fund would also
yield carry income as it approaches its eventual close in
FY2017-18. The real estate funds have seen significant
investor interest in their new fund-raises, and the newer
funds are announcing their close in lesser duration and
with higher mobilization, than the earlier funds. By June
2016, the firm managed Rs 151 bn across its PMS, mutual funds
and private equity funds as compared to only Rs 30 bn back in Mar
2013 – a 5X growth.
2nd engine of ROE growth: Starting the affordable
housing finance business
Getting the business right was one thing. But getting the
capital allocation right was another thing. Keeping the net
worth in the loan against shares and cash-futures arbitrage
books was not proving ROE-accretive. The firm had to
find better opportunities to deploy this capital. In 2014,
the leadership took few crucial decisions. It decided to
run the loan against shares book as a spread business using
borrowed funds, not from net worth. Equity capital had
to match with equity-style returns, and debt capital had
to match with fixed-income style returns. In any case,
this book was opportunistic and was just a support to the
broking business. Funding it through borrowed funds
would mean using cheaper debt capital for this fixed-
income avenue. The arbitrage book was also wound down,
and the manpower reinstated in the broking business.
This freed up capital. Since equity-style returns are best
earned from business opportunities, the leadership studied
several opportunities that could use this capital, and
offered a large, untapped opportunity with relatively lower
risk. Within lending activities, the affordable housing
segment fitted the bill closely. Small-housing ownership
was relatively untapped in India, and was coming under
the focus of the government. But the firm did not have
the right-to-participate in this space, as it had no prior
experience. At this time, it started engaging with Anil
Sachidanand, a mortgage industry veteran, who was keen
to grow a new venture. Thus, Aspire Home Finance was
born in 2014. The home loan business is a secular growth

4
business which can yield increasing incomes and high
RoE as long as asset quality and underwriting standards
are maintained; which would justify launching Aspire as a
pillar for enhancing the firm’s RoE.
The focus of this business was to be small-ticket home
loans for retail home-buyers, not higher risk wholesale
real estate lending. This target segment was essentially
need-based for a dwelling unit. Given the profile of
this target customer and the need to assess their income,
Aspire developed rigorous models of income assessment as
part of the credit underwriting process. An experienced
team was also brought in to set up the operations of
Aspire. Stringent milestones were laid down for corporate
governance, internal audits, risk and underwriting checks.
Aspire had to get the bank-lines on its own steam, not
through corporate guarantees by the firm. Checks were
put in place for concurrent audit of files, monitoring of
cheque-delays and ensuring the underwriting quality.
Daily operations would take a back-seat if these processes
were ever to be compromised. This culture of operational
excellence resulted in Aspire receiving a higher rating
than what a start-up mortgage firm would have otherwise
received. It even got rating upgrades during its initial years
of operations, which would augur well for future fund-
raises.
Since the first milestone was to establish proof-of-concept,
the capital deployment into this venture started out with
only Rs 1 billion. As Aspire expanded in the provinces of
Gujarat, Maharashtra and Madhya Pradesh, and backed
its operations by carrying out all the monitoring and
governance tasks periodically, it established it’s right-to-
participate. As of June 2016, Rs ~4 billion of the firm’s net
worth had been deployed into Aspire as equity capital.
Since the last two years, the new venture has clocked solid
traction in both assets and liabilities, while maintaining asset
quality. It has grown its loan book, expanded its branch
network and cracked banking relationships for long-term
funding. This business delivered profits in its first year of
operations, and contributed meaningfully to firm’s profits in
its second year. As a result of its operational excellence, it
received rating upgrades which should augur well for future
fund-raise.
3rd engine of ROE growth: Sponsor commitments into
own asset management and private equity funds
While Aspire would regularly utilize the excess net worth
from the firm’s balance sheet more productively, it was still
not enough to address its immediate challenge of finding
productive sources for deploying the entire freed-up net
worth. The deployment into Aspire home loan business
was going to be over phases,as and when it reached periodic
milestones. The firm still had a sizable amount of capital
left to deploy. Returning to its area of core competence,
the leadership decided to take this commitment further.
Why not put your money where the mouth is? If its core
competence was active-investing in equities and it believed
it had established its QGLP investing process stringently to

5
identify multi-baggers, then why not deploy the net worth
in those opportunities? The track-record of its QGLP
investing process stood testimonial in its PMS schemes –
the Value PMS had delivered ~25% CAGR in 13 years
and the NTDOP PMS saw ~18% CAGR since 2007 (check
Disclaimer in Q4FY16 earnings presentation). Having your
own skin in the game would be the ultimate conviction one
could show for their own business! If the leadership of an
aircraft company does not fly in its own aircraft, how could
passengers have the comfort in riding in it? In the same
vein, the firm’s commitments to its own investing process
would give further comfort to clients. Thus, Rs ~6 billion
of the capital was deployed over-time into the firm’s own
mutual fund products and Rs ~2 billion was invested into
the firm’s own private equity funds.
Not only did this show the firm’s own conviction in its
investing prowess, but it also helped seed those new
businesses effectively. Its asset management business under
thenewavatarofmutualfundswasanew-kid-on-the-block
in the Indian funds industry, and this commitment helped
the firm’s distributors to pitch the conviction of the QGLP
process to prospective clients while selling the firm’s funds.
Even the private equity business was rapidly expanding via
new fund-launches in both growth capital and real estate
spaces. In this process, these sponsor commitments to its
own asset management and private equity funds helped
seed those businesses, since it gave a huge selling-point for
the distributors to leverage on. If this were not enough,the
firm’s two promoters liquidated their personal investments
and redeployed it into these mutual funds. That meant
total alignment of interest on investment ideas. Very few
firms in the asset management space had seen this level of
commitment in their own funds.
Apartfromthese,thesponsorcommitmentsalsorepresented
a war-chest which could be deployed as commitments
to the Aspire home loans business, as and when needed.
The new home loans venture was in growth-phase. These
commitments, along with the free cash-flows from the
matured capital market businesses, would address this.
Moreover, these investments are yet to show realized gains
in the firm’s P/L statement, since the gains are yet to be
booked. As of June 2016, the unrealized gains on the
mutual funds commitment alone was Rs ~2 billion. The
private equity funds would return capital as and when it
exited holdings, and Aspire was yet to pay dividends on
the capital.
4th engine of ROE growth: Reinventing its capital
market businesses as per changing trends
Apart from returning to its core competence and
redeploying net worth to more productive opportunities,
the leadership also recognized that it needed to reinvent its
original capital market businesses, if they were to remain
relevant. The way the business was being done was fast
changing! Digitalization was changing the rules of the
game, and those ‘slow in turning the steering-wheel’ were
losing out in the race. The firm had to adapt to new ways
if its value-proposition to remain relevant for the new-
age client. While it had the right-to-participate in these
businesses, it meant it needed to reinvent its right-to-win.
This meant the firm had to invest in relevant resources to
capture this evolving opportunity.
At this time, the leadership studied the US market closely
to understand how the retail financial advisory market
had evolved there in terms of value-propositions, after
the advent of technology. Three distinct models seemed
to emerge in USA. First was execution focused platforms
who served high-frequency traders at low trade costs.
This segment did not focus on advisory, per se. Second
was the supermarket model, where clients needed hand-
holding and support in terms of knowledge resources and
advisory tools. This opened up the market to new clients.
Third was the advisory model which was relationship
driven and technology tools supported the service delivery
and decision-making of clients. Clients preferred the
personalized approach of the advisors. This was the
segment that the firm had been targeting in India.
With the economic outlook and market sentiments
improving following the 2014 federal elections in India,
the leadership took a conscious call to invest in these
critical resources up-front instead of investing after the
recovery phase had taken hold. This would give it three
advantages – the resources would be available at a more
competitive price if hired up-front, the pay-back period of
recovering these investments would be longer and it would
get a longer period to develop the systems and processes so
that the offering would be up-and-running once market
volumes improved. These targeted investments impacted
its costs up-front, but their benefit is expected to bear yield
over the long-term.
Since 2014, the firm’s broking business invested heavily
in talent in advisory and technology. Technology had the
power to engage an increasing number of Do-It-Yourself

6
customers through a single platform, while freeing-up the
bandwidth of the advisors to concentrate on clients who
needed hand-holding or discussions. Thus, technology
offered immense scope to capture operating leverage
over the long-term, despite the initial investments. Since
the last two years, the firm has launched India’s 1st and
fastest 15-minute trading and demat account using eKYC
process, India’s 1st smart watch app, revamped its mobile
trading app with superfast trading and one-time login
and launched a new broking portal with single sign-on
to trade, quick order-execution window and portfolio
restructuring. These tools have captured the imagination
of a new-generation of retail customers by providing access
and convenience at the click of a button. The overall user-
experience resulted in repeated visits, and now online
business comprises as much as ~45% of overall volumes.
Investments into advisors continued across dedicated
desks, in line with its traditional method of serving clients
through personalized advisory services. It also meant
developing system-driven tools like portfolio-restructuring
tool and portfolio strategy products, which were a key
value-offering to clients to manage their investments.
Recognizing that many retail investors were keen to earn
long-term inflation-beating returns but were not entirely
comfortable taking single-stock exposure, the firm focused
on an assets-based financial product distribution approach.
This meant not only broking, but also diversified products
like equity mutual funds, PMS, bonds, insurance and
suchlike. The firm, in turn, would earn trail-income on
the financial products distributed, which would then help
its revenue sources counter the inherent cyclicity of the
transaction-based pure broking business.
During 2015, the firm decided to invest in an equity
capital markets team in investment banking, to meet
the emerging opportunities in capital raising once the
economic recovery set corporate capex plans into motion.
In wealth management, the open-architecture product
suite complemented its in-house manufacturing expertise
in public equities and real estate products. This was
complemented with technology-tools to make the life
of the relationship manager simpler, so that they could
concentrate on client-facing activities. These helped
attract a number of new relationship managers into the
firm, the key driver to grow this business. Moreover, the
higher share of real estate and equity within its AUM mix
gave it a more favorable blended yield on assets.
Since the last two years, the firm has improved its equity
broking market share. In the retail business, the average
number of clients added per month in FY2016 was 2.2X
of what it was back in FY2014. It managed Rs 298 bn in
depositary assets as of June 2016 as compared to Rs 110 bn
as of Mar 2013 - a 2.7X growth. The firm’s digital business
has picked up significantly,and online business contributes
as much as 45% of overall volumes now. Several franchisee
partners have grown manifold in the size of business. In
institutional broking, it continues to be ranked amongst
the top local brokers across parameters in prestigious
award forums like Asiamoney. The wealth business has
seen traction in RM-count and assets. It managed Rs 74
bn in wealth AUM as of Jun 2016 as compared to Rs 20
bn as of Mar 2013 – a 3.7X growth. Since inception, the
new equity markets investment banking team has already
participated in IPO and QIP issues,setting the transaction
flow into momentum.
Becoming better in bad times, so that one can become
bigger in good times
While transforming the business model, it was equally

7
important to maintain productivity and efficiencies
for business performance. The leadership put in place
measurements of productivity, including non-sales metrics.
In the broking business, it measured the number of times
the advisor or management personally interacted with each
client. Buildingpersonalrapportwiththebusinessmanagers
across hierarchies was critical to control client-attrition in
case the advisor left. Unlike the perception that an outgoing
advisor took his clients with him, the relationships it built
across hierarchies helped it retain clients even when an
advisor exited. The periodic interactions with clients across
hierarchies also helped maintain brand-recall in the minds
of the client. To measure the success of its core competence,
the firm put in place processes of measuring the strike-rate
of its research calls in order to track the quality of the calls.
It put in place value-add services for franchisee partners
to help them improve their productivity, including business
performance measuring tools,knowledge-sharing seminars,
sales training sessions, etc.
Hire Maruti and make them into Mercedes
The promoters were first-generation entrepreneurs, who
built this business on the basis of intellectual capital. In
a relationship-driven business like financial services, it
was critical to nurture the correct talent. Hiring star-
performer mavericks meant high costs, and they were only
as loyal as the incentives. Higher chance of attrition meant
loss of few months to bring back the business on course.
Instead, the firm stressed on young talent, and giving
them an environment of learning, mentoring, growth and
incentives which would motivate them to take on more
responsibilities and become future leaders. Not only did
this ensure a motivated workforce, but it also ensured a
longer-serving workforce. Most of the business heads in
the firm had not joined originally to head that business,
but have grown from within the firm. Most of them have
now spent an average 10 years with the firm. This shows
the level of motivation and passion. Ownership stakes
were offered to key people in order to ensure the firm’s
profitability remained high on their agenda. The Maruti
in the section’s title refers to the popular people-hatchback
car, while Mercedes refers to the premium luxury car.
If the purpose and process are right, the results
will follow
The firm had faced the challenge of a declining ROE till
2014. By bringing in a transformation in its business model
since then,the deployment of the capital was turned towards
better-yielding, sustainable opportunities. These gains
would be notional now, since the home loans business is yet
to pay dividends and the asset management commitments
are still held at cost. But the track record of its QGLP
process, coupled with the operational excellence it built in
the home loans venture, gives the comfort that it has geared
the firm towards a sustainable long-term ROE of 20%+.
Its financials are showing an initial impact. The RoE on reported
profits during Q1FY2017 reached 22% (annualized), which is
over the target RoE of 20%. This does not include unrealized
gains on the commitments made in its asset management
products, including which the profits and RoE should
be higher. The objective is to now sustain this RoE over
20%-level over the long-term. Revenues in FY2016 were
the highest since the firm’s inception, while the profits
were near its all-time high ever. The revenue and profit
mix is showing an impact, as asset management and home
loans comprise an increasing share in the mix.
During the previous cycle, the firm’s performance was
driven by only one engine - the broking business. This
catapulted its profits 10X from FY2003 to FY2008. After
this transformation to the business model, the firm now
has 4 engines of long-term, sustainable ROE growth. As
Q1 FY2017 ends and the initial results become visible,
the leadership’s faith in the adage that if the purpose and
process are right, then the results will follow holds firm.
Sameer Kamath & Sourajit Aiyer

Motilal Oswal Case Study in Switzerland financial magazine - Sep 2016

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Motilal Oswal Case Study in Switzerland financial magazine - Sep 2016