Banking sector funds: Invest

With talk of green shoots in the economy, it may be a good time to bet on sectors that are well placed to play the recovery theme. Banking is one such sector, directly linked to the fortunes of the economy.

GDP growth being at a low currently and interest rate close to previous highs at 9 per cent present a strong case for the banking sector to outperform in the long run, after growth picks up. Here’s why.

The performance of bank stocks more or less ties in with movement in the GDP (gross domestic product). This year, banking stocks have been volatile, beginning the year on a positive note with hopes of rate cuts and growth pick-up, only to end with higher interest rates and a far lower growth clamping on hopes.

Loan growth has been 2.5-3 times the real GDP growth in the past. Any recovery in GDP will directly reflect on the banking sector in terms of higher loan growth and lower risks to asset quality as corporate profitability improves.

Also, the current yield on the 10 year G-Sec has already factored in another 25 basis points rate hike by end of March 2014. Thus interest rates have more or less peaked, and a downward trend in the next 12-18 months bodes well for the sector, reducing the cost of funds and improving earnings. The divergence in performance of banking stocks may also tend to narrow. While private banks have managed to hold ground even in challenging times, earnings of public sector banks have eroded with deteriorating asset quality. When the turnaround happens, public sector banks will gain significantly, on write-back of provisions made for bad loans.

The sector is already starting to see some respite with the RBI rolling back most of its liquidity tightening measures it introduced in July. In fact, since the beginning of September, the BSE Bankex has gone up by 31 per cent.

Banking sector funds have more or less tracked the performance of the sectoral indices. Of the top performing funds, ICICI Prudential Banking and Financial Services Fund have beaten the benchmark over one- and three-year time periods.

The fund was started in August 2008. On an annual rolling return basis, the fund has outperformed its benchmark 7 out of 10 times in the last five years, a record that’s better than peers. In 2009-10 alone, when the BSE Bankex went up sharply by 121 per cent, the fund marginally underperformed, delivering 112 per cent return.

In 2012-13, the fund delivered 19 per cent return, against the benchmark’s 9 per cent. This was due to the fund’s exposure to non-banking finance companies such as Mahindra & Mahindra Finance, Sundaram Finance, and Max India. These stocks rallied by 35-45 per cent at the back of new banking licences being issued by the RBI.

Religare Invesco Banking Fund has been another fund that has performed well over the last five years, but its rolling return is lower at about 60 per cent. While it did outperform the benchmark in 2012-13 it lagged ICICI Prudential Banking Fund due to its lack of exposure to non-banking stocks.

Reliance Banking Fund, since its inception in 2003, has outperformed the benchmark half the time. From 2011-12 onwards, though, this fund has been an underperformer. The fund’s top two holdings during 2011-12 consisted of ICICI Bank and SBI both of which declined 19-22 per cent, while lower exposure to HDFC Bank, which was up 11 per cent, led to its underperformance.

As with the Religare banking fund, a lower exposure to non-banking companies (barring Bajaj Finance) stymied performance in 2012-13.

Of the three funds, investors can buy units of ICICI Prudential as they seem to have a better track of beating the benchmark in the previous rate cycles. Both Religare Invesco and Reliance Banking Fund, however, warrant a closer look to see how well they deliver over the next rate cycle.

Themed funds such as this, however, are suitable only for those investors who can monitor trends and book profits at the right time.

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