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The ideal time to invest in sector funds is during a downturn so that investors can capitalise on a turnaround in 1.5 to 2 years.
Banking and financial sector funds, which lagged other equity fund categories in 2023 and 2024, are now attractively positioned.
Valuations are appealing. If credit growth picks up, these funds could reward investors handsomely.
Reasons for underperformance
Banking sector funds underperformed in the past couple of years due to multiple factors.
"The key ones were regulatory actions around the loan-to-deposit (LDR) ratio and increased risk weights in unsecured segments; uncertainties around slippages in unsecured loans; and concerns over slowing credit growth," says Roshan Chutkey, senior fund manager, ICICI Prudential Banking and Financial Services Fund.
Earnings growth and valuations also played a part.
"Three years ago, earnings growth in the banking sector was around 13-14 per cent. However, many other sectors were growing at around 20 to 25 per cent, and their valuations were also cheaper," says Amey Sathe, fund manager, Tata Asset Management.
The sector has borne the brunt of selling by foreign institutional investors (FIIs).
"Approximately 40 per cent of the selling has happened in financials," says Sathe.
The insurance sector has experienced de-rating due to regulatory pressures.
Positive drivers
Loan growth: Fund managers are optimistic about loan growth. They expect corporate loan demand to rise as private capital expenditure (capex) picks up over the next 12 to 18 months.
"Over the past three-four years, loan growth was primarily driven by retail loans.
"Going forward, corporate loan growth is expected to complement retail loan growth, resulting in an overall loan growth rate of 14 to 15 per cent," says Sathe.
Gaurav Kochar, Fund Manager- Equity, Mirae Asset Investment Managers (India) expects capex, which slowed during the first half of FY25 due to elections, to recover significantly in the second half of FY25 and in FY26, driving credit growth.
Large banks with strong liability franchises are well-positioned.
"These franchises can lend to high-quality customers at competitive rates due to their low cost of funds, enabling them to navigate system-wide asset quality challenges effectively," says Chutkey.
Rate cuts: Rate cuts are also on the horizon.
"Our base case scenario is two rate cuts in FY26. This could propel growth and consumption, both of which will benefit credit growth over the medium term," says Kochar.
Valuations: Valuations are at historic lows.
"The Nifty Bank's discount to the Nifty 50 is at a lifetime high. Many large-cap banks are trading even lower than the lows seen during the COVID-19 pandemic or the global financial crisis. Many midcap banks are also trading at low valuations," says Sathe.
Hemang Kapasi, director at Sanctum Wealth, fund manager and principal officer, PMS investment, mutual funds, and stocks, notes that pre-COVID, financial services and banks traded at 2.3 to 2.5 times price-to-book on a one-year forward basis but are now trading at 1.7 to 1.8 times.
Non-banking financial companies (NBFCs), previously at 3-3.5 times price-to-book, now trade at 2.3 to 2.5 times.
Risks to watch out for
The performance of these funds depends heavily on credit demand.
"Slowing GDP growth in recent quarters could adversely impact the performance of BFSI funds," says Abhishek Kumar, a Securities and Exchange Board of India-registered investment adviser and founder, SahajMoney.com.
Sathe warns that a sharp rise in corporate credit stress or a significant slowdown in GDP growth -- from 6.5 to 7 per cent to 3.5 to 4 per cent -- would hurt the sector.
These funds would also be affected if non-performing asset (NPA) concerns become broad-based.
"The key risk lies in these issues spilling from unsecured into secured loans such as housing and auto," says Kochar.
Should you invest now?
The ideal time to invest in sector funds, according to Kapasi, is during a downturn so that investors can capitalise on a turnaround in 1.5 to 2 years.
"Valuations are currently at one standard deviation below the long-term average. Mean reversion and re-rating are expected as the growth outlook improves," says Kochar.
If you decide to invest, remember that sector funds carry concentration risk.
"Be prepared for volatility in their returns," says Kumar.
He recommends limiting exposure to 10 to 15 per cent of the equity portfolio and having an investment horizon of three to five years to mitigate risks.
Disclaimer: This article is meant for information purposes only. This article and information do not constitute a distribution, an endorsement, an investment advice, an offer to buy or sell or the solicitation of an offer to buy or sell any securities/schemes or any other financial products/investment products mentioned in this article to influence the opinion or behaviour of the investors/recipients.
Any use of the information/any investment and investment related decisions of the investors/recipients are at their sole discretion and risk. Any advice herein is made on a general basis and does not take into account the specific investment objectives of the specific person or group of persons. Opinions expressed herein are subject to change without notice.
Feature Presentation: Ashish Narsale/Rediff.com
