Should you invest in banking funds?

As these have been the most volatile during the past year, limit your exposure in 2014

Banking sector funds have given retail investors sleepless nights this past year, on high volatility and poor performance. In 2013, they emerged as the worst category of mutual funds across all categories, returning -12.39 per cent, as compared to the BSE Sensex’s 9.23 per cent gains. They also underperformed infrastructure funds (-6.87 per cent), according to data from Value Research. The big question now is whether retail investors should buy or stay invested in banking funds.

Within the banking funds category, PSU bank or index funds underperformed significantly. The CNX PSU bank index lost around 31 per cent this past year, while the funds that mirror this index fund lost around 27 per cent. Actively managed funds faced negative returns, too, with most clocking returns of -12 per cent. A relatively better performer was ICICI Pru Banking and Financial Services Fund, which posted a negative return of -2.6 per cent.

Banks were faced with a very tough 2013 as the Reserve Bank of India's measures to defend the rupee in the middle of 2013 saw some tough liquidity tightening and interest rates increases. PSU banks also saw a fall in earnings of around 47 per cent (yoy), as against a strong earning growth of 23 per cent (yoy) for the private sector in the second quarter of FY14. The stress in PSU banks asset quality increased, with gross NPAs at 4.52 per cent. Private sector banks’ asset quality was stable at 2.02 per cent. However, PSU banks have recovered from their lows in recent times.  

Still, experts say the sector’s volatility is expected to continue for a few quarters. RBI is likely to increase rates further if inflation does not ease. However, the overall outlook for 2014 looks much better, as the asset quality is expected to stabilise, while the rupee is showing signs of stabilising. Says Vaibhav Agrawal, banking analyst, Angel Broking: “The next year is going to be much better for the banking stocks, with liquidity pressures and interest rates having eased.” Further, bank deposits are expected to grow as interest rates rise, while credit growth will likely slacken thus reducing the net interest margins. Bank deposits grew at 17 per cent year-on-year as on December, while credit growth grew 15 per cent.

Experts advise if investors can stomach the volatility of the PSU banks in the next few quarters, they could remain invested in these. Says Daljeet Kohli, head of research, India Nivesh: “In the past year, PSU banks saw a downgrading due to asset quality slippages. Now most of them are quoting at very low price to book values, which means any good news from them could result in a better stock performance.”

If you already have some exposure to PSU banks exchange-traded funds, experts’ advise to remain invested for now, as the worst seems to be behind. But avoid fresh exposure, as the sector is still volatile and the choppiness will continue for a while. Or invest very little in this space.   Private sector banks, on the other hand, are better placed on liquidity and are logging better growth rates, beside trading at attractive valuations. Says Agrawal: “Most private banks are better placed, should manage to hold on to their growth rates and are also going cheaper.” Hence, investors could continue to hold or invest small amounts in actively managed banking funds, with a large chunk in private banks. Investors have to, however, see the recovery in the investment cycle, which means holding on to these funds for at least a one or two-year horizon.