Correction in banking, financial funds: Exit if unable to handle volatility

Stay invested only if you have strong conviction, understand the sector, and can time your entry and exit

Banking and financial services funds have declined 9.5 per cent over the past month, making them the third worst-performing equity category during this period. The category is sizeable, with assets under management (AUM) of ₹1.08 trillion across 71 schemes.

 

Factors behind the recent correction

 

Experts say higher financial leverage makes the banking sector more vulnerable to headwinds than other sectors.

 

The ongoing war has created macro risks through high energy costs and disrupted supply chains. “These risks can affect loan growth, liquidity conditions, and asset quality if the war is prolonged,” says Bhavesh Kanani, fund manager at UTI Asset Management Company (AMC). 

Asset quality concerns have also emerged as artificial intelligence-led changes could result in job losses.

 

If the geopolitical situation persists, macro sentiment could deteriorate further. “These factors could weigh heavily on earnings growth, which was expected to revive gradually,” says Kanani.

 

Growth in advances has improved since the end of December 2025, but deposits continue to lag. “This raises concerns over the sustainability of the current growth momentum,” says Abhijith Vara, fund manager, Mirae Asset Investment Managers (India).

 

He adds that persistent selling by foreign institutional investors has also weighed on performance.

 

Positives that may offer resilience

 

Despite these pressures, the banking sector remains fundamentally strong, with adequate capitalisation, provision levels, and a diversified loan mix.

 

Banks and non-banking financial companies (NBFCs) continue to play a critical role in expanding organised lending, funding corporate capital expenditure, and supporting financial inclusion.

 

The overall financial services space has expanded significantly. “There have been several initial public offerings in wealth, financial planning, insurance, and fintech,” says Vara.

 

Some segments could see stronger growth going forward. “Insurance, wealth technology, and financial services aggregation players are expected to drive the next phase of financial services growth. Banking and financial services funds can capture some of these new-age investment themes,” says Vara.

 

After the correction, valuations have turned more attractive. “They offer value to long-term investors. A quicker resolution of the war situation would remove some of the concerns and create upside potential,” says Kanani.

 

Existing investors: Stay or exit?

 

The financial sector is a proxy for the broader economy. “The sector often leads market recoveries and remains a key beneficiary of domestic economic expansion,” says Abhishek Kumar, Sebi-registered investment advisor and founder, SahajMoney.com. Staying invested allows investors to ride out the cyclical nature of the industry without locking in short-term losses. Selling during temporary volatility could make investors miss the benefits of long-term compounding.

 

Investors with strong conviction about the banking and financial services sector’s prospects may stay invested. “Continue if you think that your original thesis on India’s credit growth remains intact,” says Kumar.

 

That decision, however, should rest on research and a clear understanding of the sector. “Investors should have a deep understanding of the sector’s nuances and the ability to time entry and exit,” says Kaustubh Belapurkar, director – manager research, Morningstar Investment Research India.

 

An exit makes sense in some cases. “Exit if your portfolio is heavily overweight on this sector and you have met your personal goals ahead of schedule," says Kumar.

 

Sectoral and thematic funds remain inherently volatile. Many investors may not have the appetite for such swings. Such investors should exit and shift their money to diversified equity funds.

 

Markets go through sector rotations, and different sectors lead at different times. Investors may exit if they do not like the lumpy returns these funds generate.

 

“Investors should also exit if they invested only because the sector has performed well in the previous year,” says Belapurkar.

 

Financial services is the largest sector in the index. Most diversified equity funds already hold around 25 to 35 per cent in financials. A separate banking and financial services fund can increase the risk of overexposure to the sector.

 

Should new investors enter now?

 

Most retail investors may avoid banking and financial services funds because they would already have adequate exposure to the sector through diversified equity funds. Those who still wish to enter should first understand the risks involved.

 

“These funds carry significant timing risk. Investors can get the timing wrong at both entry and exit,” says Belapurkar. He adds that only investors with a strong view should consider sector exposure.

 

Such investors must also be able to withstand volatility. “New investors should stagger investments through systematic plans to mitigate the impact of near-term interest rate fluctuations and global macro uncertainties,” says Kumar.

 

Belapurkar says allocation should be limited to 5 per cent per sector, while total allocation across sector funds should be capped at 10 per cent of the portfolio.

 

Experts say prescribing a minimum investment horizon for sector funds is difficult because success depends on getting both entry and exit timing right. “Investors need to enter before the turnaround happens and exit when the sector is at its peak. Most investors enter after the run-up has already happened,” says Belapurkar.

 

Kumar recommends a minimum investment horizon of five to seven years because it mirrors the economic cycle. “Such a duration can help investors ride out credit cycles,” he says.