After being the most preferred in the Indian equity indices for over half a decade, things might be about to change for stocks in the financial sector. Comprised of banks and non-banking financial companies (NBFCs), the share of financials in the bellwether CNX Nifty has dipped from 40.1 per cent at its peak on February 19, 2020, to 37.8 per cent on Thursday.
This marks the first major decline in weights of financials in the index in the last five years, and the reduction might be directly correlated to the massive sell-off that has intensified in the past three weeks.
To put things into context, foreign institutional investors (FIIs) were heavily positioned in the Indian financial space, and stocks in the sector witnessed maximum inflows during good times. “Most of these inflows were through passive funds or index funds, which are now facing margin triggers or redemption pressure and are being forced to cut their positions in Indian financial stocks,” said the trading head of a foreign brokerage. But, the sell-off isn’t entirely led by technical factors.
Mahesh Patil, chief investment officer — Equity, Aditya Birla Sun Life Mutual Fund, says even globally because of the onslaught of the novel coronavirus (COVID-19) and growing signals of recession, these passive funds are trimming their positions in financial stocks. “In India it is a double blow in the form of YES Bank fallout and prolonged slowdown which increases the chances of credit quality deterioration,” said a fund manager who did not want to be named.
The Nifty 50 index is a free float market capitalisation weighted index, which indicates that as the market value of a company/sector falls, it impacts its weight in the index.
Experts don’t rule out a further reduction in weights of financial stocks. While almost every foreign brokerage, whether JP Morgan, Morgan Stanley, Credit Suisse, CLSA or UBS is overweight on the Indian financial space, Nomura is among the few that were quick to change stance.
In a report, Saion Mukherjee, head of research — equities, Nomura, said there was earnings risk in India, primarily driven by financials, autos, information technology and metals. This led to the brokerage reducing its weight on financial stocks. “A prolonged weakness and global sell-off could trigger more brokerages to change their stance on the sector,” said a head of research at another foreign research house.
Domestic investors feel it may be too soon to turn averse to banking and NBFC stocks, though an extended impact of the pandemic may affect these stocks. “Covid-19 related impact isn’t fully known yet and it is too early to predict how it can affect the earnings. But, if it turns out to be worse than expected, investors could turn underweight on the (financial) sector and their weights in Nifty may reduce,” Patil explains.
However, as domestic investors are concentrated on financial stocks, experts say the opportunity for them to increase their exposure to the sector is slim. “Those with strong liability franchise may be attractive after the correction,” says Patil. Experts say the next two weeks will be critical to take sectoral and stock-specific calls.