The market rally has added a layer of complexity to equity investing in India. With Nifty50 trading near lifetime highs, on high valuations and high earnings growth, opportunities for fresh positions are limited. One sector that has flown under the radar is the banking segment. The sector found a fresh impetus post-Covid having cleaned its balance sheets from the previous decades’ exuberant lending practices.
We look at the mutual funds route for investing in the banking segment.
With a plethora of options in both active and passive strategies, and an equally good return performance, investors have many options in the segment. We recently recommended Nippon India ETF Bank Bees in the passive space. In the active space, investors can consider ICICI Pru Banking & Fin or Nippon India Banking & Financial Services funds, which have delivered high returns and beaten benchmark consistently.
Valuations, earnings growth
Nifty Bank, trading at 15.5 times trailing earnings, is at a 30 per cent discount to its last five years trailing PE. Even on a trailing price to book ratio, the index is in line with its five-year average at 2.4 times. Nifty50, on the other hand, trading at 23 times trailing earnings or 3.8 times price to book (trailing), is in line with its five-year average and at a significant premium to banking stocks.
The sector returns have also been underwhelming. In the last year or last five years, the banking index has returned 13 per cent/62 per cent compared with Nifty50 returns of 26 per cent/92 per cent. This despite a strong earnings growth for the banking index which exceeds Nifty50 earnings growth in the last two years. Nifty Bank has reported earnings growth CAGR of 29 per cent in FY21-23 compared with Nifty50’s CAGR growth of 21 per cent in FY21-23. But it has to be noted that consensus estimates for Nifty50 for FY23-25 are higher at 20 per cent compared with 17 per cent for Nifty Bank index.
Strong credit growth led by retail segment and lower credit costs are current drivers for the sector. The much-anticipated rebound in private capex post elections and an expected rebound in net interest margins driven by interest rate cuts can sustain the earnings momentum of the sector. The optimistic Indian GDP growth estimates for FY25 and beyond are also positive tailwinds for the sector.
Mutual fund route
Despite positive undercurrents for the banking sector, investors can invest in phases considering the pending election outcome and uncertainty in global financial macros and geo-political unrest.
There are 11 mutual funds with more than five years of history in active mutual funds. Nippon and ICICI’s banking funds have delivered an daily average five-year CAGR growth of 16.9 per cent and 16.3 per cent respectively since their introduction. Also the two funds have returned negative returns over a five-year period — a negligible less than 1 per cent of the time since inception.
Compared with a benchmark – Nifty Bank TRI over their operating periods, of the 11 funds, only five funds have beaten the benchmark on daily average five-year CAGR growth.
Over a shorter timeframe of three years, the same two funds lead the charts but with the addition of Mirae Asset’s banking fund (but shorter 3.3 year history).
In the passive space, there are a few mutual funds tracking the index but primarily ETFs of which there are four with more than five-year history. Of the four, Nippon Nifty Bank ETF has the least tracking error with Nifty Bank index at 13 basis points over five daily average of five year CAGR returns. The ETF also delivered an average five year CAGR of 15.3 per cent which is comparable to the leading active funds and better than most other active funds. For investors looking at passive route of investing which involves lower expenses, this fund can be ideal.