Strong rebound in BFSI funds makes a good case for taking an exposure

Since these funds can be volatile, limit your exposure to 5 per cent

Banking and financial services funds have rebounded strongly with a category average return of 13.5 per cent (for direct, active funds) over the past three months. They have surpassed the Nifty total return index (TRI) which is up 8.8 per cent over the same period. However, their one-year return average return is anaemic (1.7 per cent) due to their underperformance in late 2021 and early 2022. Given their recent performance, however, investors may take a fresh look at these funds.

Diversified exposure

Banking and financial sector funds give exposure to a wide range of sub-sectors: banking, housing finance, insurance, asset management companies, exchanges, brokerages, and non-banking financial services. Since most of these financial services have achieved very low penetration in the country until now, they have a long growth runway ahead of them.

“Banking sector is the pivot around which the economy grows. The low leverage levels in the economy and the growth potential of the sector should aid these funds’ returns,” says Roshan Chutkey, senior fund manager, ICICI Prudential Mutual Fund.

Clean balance sheets

Banks have cleaned up their balance sheets in the recent past. The Insolvency and Bankruptcy Code has put in place processes for dealing with defaulters. “Credit growth has improved, balance sheets of most large sector participants are in very good shape, and the non-performing loan (NPL) issue has subsided. It’s a large, liquid sector that allows investors to participate in the recovery of the domestic economy,” says Vinay Sharma, fund manager, Nippon India Mutual Fund.

Buoyed by capex push

Initiatives such as the production-linked incentive (PLI) scheme are boosting India Inc’s capital expenditure. As credit demand rises, lenders are expected to benefit from rising volumes as well as healthy net interest margins. Uptick in key industries such as housing is another positive. “India’s capex and real estate recovery will positively impact banking sector funds,” says Sharma.

Active and passive options

In the past, investors had the option to invest in actively-managed funds. But now a number of passively-managed schemes, which track indices such as the Nifty Bank index and the Nifty PSU bank index are available. In fact, the three biggest funds within this space—from Nippon India, Kotak, and SBI—are passively managed.

“Some active funds have outperformed the benchmark index at various points in time. Hence, it is advisable to invest in actively-managed funds,” says S Sridharan, founder & principal officer, Wealth Ladder Direct. Chutkey says in actively-managed banking funds the fund manager can take judicious calls to navigate various risks.

With a passive fund, however, the investor removes the risk of underperformance and is assured of benchmark-equivalent returns.

Risks remain

Any sector fund is more volatile than a diversified-equity fund. Banking and financial sector funds gave poor returns in 2015, 2018, and 2020. These funds also carry higher concentration risk.

The global economic environment is a potential source of risk for them. “A strong dollar and a high interest-rate environment could potentially lead to event risks on the global front. Besides, the still high inflation will keep the Fed from easing. These factors could potentially put pressure on the rupee, lead to liquidity tightness, and hence to a slowdown of the economy,” says Chutkey. Banking and financial services funds are bound to bear the brunt of a possible slowdown in the economy.

What should you do

If after the recent bounce back of these funds, you are feeling tempted to invest, consider the following. Most of the diversified-equity funds in your portfolio, especially the large- and flexi-cap funds, would already have significant exposure to this sector (since the Nifty 50 has 36 per cent exposure to banking and financial services).

Invest only if you wish to go overweight on the sector. “Exposure to all sector funds combined shouldn’t exceed 10 per cent of the equity portfolio. Banking funds may be included in your satellite portfolio, not in the core portion,” says Sridharan.