Banking funds have gained from global inflows amid US-China deal hopes

But beware that NBFCs with high exposure to real estate are not out of the woods yet

Banking and financial sector funds have witnessed a sharp runup in recent times. They are up 19.41 per cent over the last year. Of this, 16.24 per cent returns have come in just the last three months.

Several factors have contributed to this rise. “Flows to emerging markets have been strong in the past few weeks amid optimism about a trade deal between the US and China. A view is also developing that emerging markets (EMs) may have a better time in 2020 than in 2019,” says Vinay Sharma, fund manager, Nippon India Mutual Fund. India has been a large recipient of the flows into EMs. And within India, since financials constitute a large part of the total market cap, they have received a substantial portion of the flows.

According to Roshan Chutkey, fund manager, ICICI Prudential AMC: “Besides global liquidity, the recent positive measures announced by the central government to address the economic slowdown have also aided the performance of banking funds.” The government has cut the corporate tax rate, come up with an aid package for real estate, and embarked on recapitalisation and consolidation of public-sector enterprises.

Risk appetite is returning to the financial sector. “The market is of the view that India will avoid another large default in the financial services space, like those by IL&FS and DHFL,” says Amit Ganatra, fund manager, Invesco Mutual Fund. The recent Supreme Court judgment that affirmed the primacy of financial creditors in the Insolvency and Bankruptcy Code (IBC) procedures also boosted sentiment.  

Experts say that the burden of non-performing loans (NPL), which banks have been facing for the last few years, is in its last legs. Banks’ profitability has been depressed for the last four-five years due to this issue. It is expected to revert to normal soon.  

Continuance of an accommodative stance by central banks and further reforms by the government will help sustain this rally. Its continuance will also depend on the pace of economic revival, which would lead to an improvement in credit growth. “Valuations within the sector are still attractive from a longer-term perspective. 

 

It will also benefit from trends like rising penetration of credit, market share shift from public- to private-sector banks, and financialisation of savings,” says Ganatra. While India’s household savings rate is high, most of it is parked in non-financial avenues. The penetration of financial products and services — loans, insurance, mutual funds or demat accounts — is low, and hence, the scope for growth is humongous.

Lending is a balance sheet driven business that inevitably witnesses interest-rate volatility and asset-quality issues.

Earlier, the asset-quality risks emanated from infrastructure and commodities. More recently, they have arisen from real estate. NBFCs that have lent heavily to the real estate sector are still not out of the woods. Their health will only improve when sales pick up within the real estate sector. NBFCs’ issues could have a ripple effect on banks. “The slowdown in the economy could also give rise to fresh NPLs in small and medium enterprises (SME),” adds Sharma. Remember also that a sector fund is more volatile than a diversified fund.

When selecting a banking fund, go with one that has performed well across market cycles. The diversified equity funds in your core portfolio would already have exposure to banking and financial services. Hence, invest only a limited amount in these funds. Financial advisors say that an investor’s total exposure to sector funds should not exceed 10 per cent of his equity portfolio. After the recent runup, buy on dips or in a staggered manner via the systematic investment route.