Ride the economic growth theme with banking and financial sector funds

Any credit event could pose a risk to this sector

Over the past three months, banking and financial services sector funds have given a category average return of 17.28 per cent (according to Value Research). Experts say investors with a three-five-year horizon are likely to do well in this sector. 

The banking sector provides credit. Irrespective of whether investment or consumption does well in future, the banking sector will stand to gain. Investors who wish to ride on India’s economic growth story can bet on it. “The market is of the view that with a strong mandate, the new government will be able to take decisive policy actions and undertake reforms that support economic growth. In the stock markets, this theme can be accessed through the banking sector,” says Roshan Chutkey, fund manager, ICICI Prudential Asset Management Company. 

Currently, there are several positive drivers that can support earnings growth in this sector. The worst of the non-performing asset (NPA) issue is over, especially for mainstream banks, though pockets within the non-banking financial company sector face distress. “The asset quality issue that many banks have been grappling with in their corporate loan books has begun to ease. As asset quality improves further, so will their return on equity (ROE),” says Dhimant Kothari, fund manager, Invesco Mutual Fund. 

Credit growth is improving and could rise further. Capacity utilisation has moved to the mid-seventies level. “In a year or so, companies will begin announcing capital expenditure plans, which will help revive banks’ corporate loan books,” says Kothari. 

There is also a high probability of the Reserve Bank of India cutting rates, and providing liquidity support through open market operations and other means. “Any support from the government, in terms of recapitalising public sector banks to kick-start credit growth, would be perceived as a positive for the sector,” adds Chutkey.

Investing in the banking and financial sector will not come without its share of risks. A key one could be further credit accidents that give rise to systemic risks. According to Vivek Ranjan Misra, head of fundamental research, Karvy Stock Broking, “If the current slowdown gets prolonged, it could result in higher NPAs. Moreover, if the reforms expected for state-owned banks fail to materialise, there will be disappointment.”

Direct stock investors, according to Misra, may bet on banks with higher corporate exposure. He specifically warns against investing in smaller state-owned banks that have still not overcome their NPA problems.

When choosing a banking and financial sector fund, look for portfolios that hold a mix of steady compounders (private banks with a track record of stable growth and healthy ROE) and players focused on corporate lending, which will benefit from the improving asset quality cycle. The loan books of players held by the fund should not be lumpy, that is, focused on risky sectors such as real estate and infrastructure. 

On the liability side, players with excessive dependence on wholesale borrowing, and those borrowing short-term to lend long term should not be there in the portfolio. Players with balance sheet risk should also not be present. Also, check the fund’s long-term track record to see if it has been consistent. Finally, the diversif­i­e­d equity funds in your portfolio wo­u­ld already have exposure to the ban­king sector. So limit your expos­u­r­e to these sector funds to not more th­an 5 per cent of your equity portfolio.