Allocate 5-10% to banking funds to gain from rate cuts, valuations

The banking sector has been facing challenges as a result of which funds focused on the banking and financial services sector have returned only 9 per cent on average year-to-date, compared to 20.5 per cent fetched by flexicap schemes.

Over the past year, banking sector funds have delivered a 24.8 per cent return, with performances varying widely. ICICI Pru Nifty PSU Bank Exchange-Traded Fund (ETF) led the pack with a 51.9 per cent return, while SBI Nifty Private Bank ETF lagged with a return of 11.8 per cent.

Investors have favoured public-sector banks while overlooking private-sector banks.

Since banking and financial services is a large listed space, it has 55 passively and actively managed funds. The most recent addition is Bandhan Nifty Bank Index Fund.

 

 

Causes of sluggish performance

A variety of factors have contributed to the banking sector’s recent underperformance.

“Regulatory actions around the loan-to-deposit ratio (LDR) and increased risk weight for unsecured segments have posed challenges. Additionally, potential slippages in these segments have made investors cautious. Concerns about slowing credit growth have further weighed on the performance of banking sector funds,” says Roshan Chutkey, fund manager, ICICI Prudential Banking & Financial Services Fund.

“Fundamental issues include lagging deposit growth and cyclical margin pressures,” adds Sumit Agrawal, senior vice president-equities, Bandhan Asset Management Company (AMC).

Rate cuts to have positive impact

In the long term, banking and financial services funds are expected to do well in an expanding economy. They will benefit from the impending interest rate cuts, as well as the stimulus the economy may get from cheaper loans.

“The banking sector is poised for better days, especially with the anticipated turn in the interest-rate cycle both globally and in India. In future, some of the best returns will likely come from banking sector funds,” says Santosh Joseph, chief executive officer (CEO) and founder, Refolio Investments and Germinate Investor Services LLP.

“Lower rates also improve credit and economic activity while reducing the interest-cost burden of corporates,” says Agrawal.

Attractive valuations 

The period of underperformance has made some banking stocks attractively valued. “Large private sector banks are in a strong position within the banking space. Their valuations are attractive, and they have the resilience to manage potential challenges in retail asset quality, should any arise,” says Chutkey.

Concentration risk 

Sector funds carry a higher risk than diversified equity funds.

“Investing in a single sector rather than a diversified fund entails more risk. It’s advisable not to go overboard on a banking sector fund or any other sector fund,” says Joseph.

Investment strategy

Investors seeking value may consider ETFs tracking indices like the Nifty Bank or the Nifty Private Bank. However, long-term investors with a positive view of the financial services sector may opt for actively managed schemes belonging to this sector.

First-time investors may find flexicap schemes more suitable. They, too, allocate a significant portion of their portfolio to financial services stocks. As of July 31, 2024, flexicap schemes had an average of 26.2 per cent of their portfolios invested in financial services stocks.

“Given its sectoral nature, investors may allocate 5-10 per cent of their equity portfolio to these funds,” says Agrawal.

Chutkey recommends the systematic investment plan (SIP) route.

“Retail investors should invest through SIPs rather than attempting to time the market with lump-sum investments,” he says.