Banking sector funds are a type of sectoral mutual fund that invests primarily in banking and financial service companies. Being a sectoral fund, it will invest 80% of its total assets in equity & equity related instruments of banks and financial instruments.

The Indian banking system consists of 27 public sector banks, 26 private sector banks, 56 regional rural banks, 46 foreign banks, 93,913 rural cooperative banks, and 1,574 urban cooperative banks, in addition to cooperative credit institutions.

The banking sector comprises of private and public lenders with big players like HDFC Bank, State Bank of India, ICICI Bank Limited, Indian Bank, etc. Public sector banks govern more than 70% of the banking system assets. Even the NBFCs and Housing Finance companies contibute to this significantly. Due to the COVID-19 pandemic, the economic disruption led to a widespread and synchronised retreat from credit risk exposures in both advanced and emerging market economies which has amplified volatility.

As per RBI monthly bulletin, net financial assets of Indian households, after having moderated in 2018-19, gathered pace in 2019-20 touching the levels reached in 2017-18, i.e., 7.7% of GDP. The improvement has occurred due to moderation in household bank borrowings being sharper than those in bank deposits.

Households’ gross financial liabilities turned negative in Q1:2019-20 owing mainly to a contraction in borrowings from commercial banks; but picked up thereafter and peaked in Q4:2019-20, reflecting higher borrowings induced by COVID-19 related hardships, apart from the seasonal uptick.

Both financial assets and liabilities of households remain bank-centric, with some shift in favour of mutual funds and insurance in recent quarters.

A seasonal pattern is discernible in at least three financial instruments, namely, currency and bank deposits on the assets side, and bank borrowings on the liabilities side.

While the acquisition of currency peaks in the first quarter, deposits and loans from the banks expand in the last quarter of the financial year.

Besides, the recent COVID-19 related disruptions and the developments in the mutual fund sector, which have emerged as one of the major lenders to the NBFC sector, have further impacted the market financing conditions for NBFCs.

The impact of these recent developments on the market financing conditions for NBFCs and assesses potential risks. The analysis is restricted to NBFCs’ market liabilities and does not factor in the potential ameliorating impact of bank credit to NBFCs, which have shown a robust increase during FY 2018-19 and 2019-20. The analysis is based on data up to the end of April 2020.

The financing conditions have become challenging in recent times, especially for lower-rated NBFCs, due to the overall environment of greater risk sensitivity and heightened risk aversion. Measures undertaken by the Reserve Bank have considerably eased the stress in market conditions.

The RBI has cut policy rate cumulatively by 250 basis points since 2019 and maintained an accommodative stance as long as necessary to revive growth.

The banking and financial services funds have performed well over the long term. The current correction in the market has provided a good opportunity to do value buying of banking stocks.

[Read: How Should a Novice Approach Mutual Funds amidst COVID-19]

Table 1: Performance of Top 5 Banking and Financial Services Funds

Scheme Name Absolute Returns (%) CAGR (%)
6 Months 1 Year 2 Years 3 Years 5 Years 7 Years
SBI Banking & Financial Services Fund -25.45 -19.46 -2.93 3.87 10.12
Invesco India Financial Services Fund -25.43 -18.87 -4.93 0.71 7.79 13.86
ICICI Pru Banking & Fin Serv Fund -30.91 -29.00 -9.07 -4.75 6.27 14.13
Aditya Birla SL Banking & Financial Services Fund -30.34 -26.20 -11.36 -3.82 6.20
Taurus Banking & Fin Serv Fund -27.45 -19.62 -3.57 1.09 5.35 10.36
Nifty Financial Services – TRI -27.49 -20.83 -2.05 3.76 7.67 13.38
NIFTY BANK – TRI -33.37 -30.13 -9.82 -2.57 3.63 10.48
S&P BSE BANKEX – TRI -33.55 -29.43 -8.90 -2.46 3.41 10.43

Data as on June 26, 2020
(Source: ACE MF; Personalfn Research)

Should you invest in Banking and financial services fund now?

The worst might be already in the stock prices. Going forward, the slightest encouraging news may spark off massive rallies in their stock prices.

On the other hand, valuations are super-rich in the case of private sector banks, but the performance of a few players has been mixed. A diligent fund manager won’t generalize anything here either and would assess each balance sheet carefully before deploying your hard-earned money.

What looks obvious often requires careful inspection.

In comparison, the portfolio traits of diversified funds have been more consistent and are largely driven by stock-specific activities in most cases, not just the sectoral trends …and hence more diversified.

Being sector and thematic, Banking Sector funds have a narrow choice for stock selection while usually follow a top-down approach. While, diversified equity mutual funds go by broader macroeconomic trends and not necessarily one sector or theme. Thus, they tend to do well during economic and market upswings.

Table 2: Average returns of market cap funds and banking and financial services funds

Category Name Absolute Returns (%) CAGR (%)
6 Months 1 Year 2 Years 3 Years 5 Years 7 Years
Banks & Financial Services -28.70 -23.84 -7.70 -2.43 4.59 10.91
Large & Mid Cap -11.88 -8.45 -2.66 0.88 5.98 14.00
Large Cap Fund -13.73 -9.64 -1.15 2.27 5.35 11.81
Mid Cap Fund -6.71 -5.09 -3.21 0.20 5.55 16.23
Multi Cap Fund -12.40 -8.56 -2.03 1.64 5.42 13.21
Small cap Fund -8.35 -10.18 -9.90 -4.70 4.36 15.10
Average returns of all market cap funds -10.93 -8.43 -3.18 0.55 5.40 13.77

Data as on June 26, 2020
(Source: ACE MF; Personalfn Research)

If you’re unsure where to invest fresh investible surplus right now to strike the correct risk-return trade-off, we recommend that you adopt a ‘core and satellite approach‘ to investing.

Here are 6 benefits of ‘core and satellite approach’:

  • Facilitates optimal diversification
  • Reduces the risk to your portfolio
  • Enables you to benefit from a variety of investment strategies
  • Aims to create wealth cushioning the downside
  • Offers the potential to outperform the market
  • Reduces the need for constant churning of your entire portfolio

‘Core and satellite’ investing is a time-tested strategic way to structure and/or restructure your investment portfolio. Your ‘core portfolio’ should consist of large-capmulti-cap, and value style funds, while the ‘satellite portfolio’ should include funds from the mid-and-small cap category and opportunities style funds.

But what matters the most is the art of astutely structuring the portfolio by assigning weights to each category of mutual funds and the schemes you select for the portfolio.

Moreover, with a change in market outlook, the allocation/weightage to each of the schemes, especially in the satellite portfolio, needs to change.

Keep in mind, constructing a portfolio with a stable core of long-term investments and a periphery of more specialist or shorter-term holdings can help to deliver the benefits of asset allocation and offer the potential to outperform the market. The satellite portfolio provides the opportunity to support the core by taking active calls determined by extensive research.

This article first appeared on PersonalFN here

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