Should you invest in banking and financial services thematic funds now?

An investor who does not have understanding of the banking space and who cannot handle volatility should avoid this thematic funds.

At present, banking sector is facing twin problems of rising non-performing assets (NPAs) and weak corporate governance practices. While the problem is more acute in the public sector banking space, some large private sector banks, too, are embroiled in issues related to corporate governance.

“Private sector banks focused on retail segment have handled the credit cycle well and are well capitalised to make the most from the growth in credit demand. But, RBI’s recent clampdown on various loan restructuring schemes will further increase the provisioning burden for stressed banks and impact their profitability in the near term,” said Manish Kothari, Director and Head of Mutual Funds, Paisabazaar.com.

However, experts feel steps like these would lead to cleaner balance sheets in the long term for banks.

To capitalise on the long term growth opportunity in banking and financial services IDBI Mutual Fund recently launched banking and financial services fund, a scheme focused on BFSI sector. Similar, funds are available for investment from other AMCs as well with 3 to 5 years track record to know how this thematic schemes have performed in the past.

Returns as on 17th May, 2018

The returns from some of the banking funds as highlighted seems decent for 3 years and 5 years. “However, if you take a 5 year or 10 year time frame, a multi-cap fund or midcap fund has beaten the banking space. This is because of the cyclicality of the sector. It is therefore becomes important to time entry and exit in the banking space.

Review banking stocks before investing

As per to SEBI regulations, banking and financial services thematic schemes are required to invest 80-100% of its funds in the banking and NBFCs. So, reviewing the financial health of banking stocks is of utmost importance before taking a call to invest in this high risks funds.

Review the banking stocks using the following parameters. These are a proven credit assessment ability that spans across economic cycles, strength of the liability franchise, the competitive positioning in terms of the loan assets, the growth potential by generating additional revenue streams such as fee income, a relatively healthy capital position and the quality of the management team. These should be seen from a perspective of relative valuations and banks’ ability to generate profitability.

Any improvement or deterioration on the above assessment parameters may have bearing on the profitability of the bank and thus will impact valuations accordingly. Also, macro-economic variables like credit growth, interest rate environment, liquidity factors and regulatory actions will have a say on how the banking stocks perform in a given time horizon.

Who should invest?

Investors having higher risk appetite with the ability to closely track the banking sector and time their investments accordingly should opt for banking funds. As this funds solely invest in banking companies, they are more volatile than diversified equity funds.

New regulations like ‘Net stable funding ratio’ and ‘Liquid coverage ratio’ for banks under Basel III liquidity standards will help strengthening the banks and hence will attract investors. A well-diversified and moderately affluent investor can surely try these funds for occasionally high profits.

Alternative investment option to have an exposure in banking sector

Bala says, “In my opinion, regular diversified funds provide sufficient exposure to banking stocks with a 30-40% exposure to this sector. This is sufficient to capture upside in this sector.” An investor who does not have understanding of the banking space and who cannot handle volatility should avoid this thematic funds.

Alternatively, it may be a better idea to pick value banking stocks individually in your portfolio than go for funds,” adds Bala. If one decides to take exposure to banking funds, the time horizon of investment is like any other equity fund i.e. 5 years and above.

Risks of investing in this funds

Since all the assets of fund are invested in a single sector i.e. banking, so all the risk associated with financial institutions and economy should be taken into account. For instance, “Deterioration in macro-economic variables adversely impacting the economic cycles and changes in regulatory landscape (for example capital requirements).

An investor needs to keep an eye on rising level of NPA’s since banks constitute a major chunk of these funds. Investors should make sure that banks in fund’s portfolio are at low NPA level. Further, there are possibilities that a situation of bank run may arise which have a cascading effect if particular bank stock is in your fund’s portfolio.

Investors should avoid indefinite accumulation of this banking funds. Any exposure more than 10-20% of your equity holding can destabilise the overall portfolio especially in uncertain periods.

Being mandated to invest in banking and financial services stocks only, their fund-managers are forced to remain invested in such stocks even if they are convinced of their under-performance in the foreseeable future.

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