Banking Fund | Financial Services Funds: How much exposure should you have in banking and financial services funds? Vinay Sharma explains | Techy Kings


“The financial sector itself has become more diverse and perhaps less cyclical than it was a few years ago. So naturally, sectors and thematic funds will be more volatile in a diversified fund and therefore investors have to acknowledge that risk and see if it suits their risk profile or not,” said. Vinay SharmaFund Manager, Nippon India Mutual Fund

Banking and financial services funds have recovered strongly with category average returns above 13%. What are the reasons and triggers behind it?
There are four or five main factors responsible for the kind of rebound the sector is seeing; especially the fundamentals of the sector have improved in the last two, three years. After the Covid crisis, there are concerns that Covid may impact the increase in Indian corporate balance sheets as well as the Indian banking system. That doesn’t happen on a large scale. The banking system’s balance sheet continues to improve even after Covid and little pressure is seen in segments where banks don’t really serve much.

Similarly, Indian corporates have been de-leveraging for the past five or six years and the story has continued in the last two years as well. These factors are combined with banking valuations at the beginning of the cycle. Again, if we talk about the post-Covid period, valuations are very reasonable relative to the market and the poor performance in the banking sector prior to this revival makes the sector more attractive relative to the market in terms of valuations as well.

Therefore, the combination of all these banking results has improved consistently for the last four or five quarters. No surprise the quality of assets coming into the system, corporate and banking balance sheets are improving consistently. One oversold technical factor for the sector is the ongoing FII sell-off.

Banking is the largest sector in India and when a large outflow happens, it is the sector that is bound to get hit whenever that happens. We have seen some slowdown in FII sales and some trend reversals as well in recent months which has also helped in the performance of the sector.

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How does growth look to you now? How will the sector develop especially when we still have geopolitical tensions and other developed economies slipping into recession? How does the sector look to you two to three quarters from now?
In terms of the fundamentals of the sector, we do not see a large-scale risk to the fundamentals of the sector. If you look at all the big segments of the Indian banking system, be it large corporate, medium and small corporate, be it retail, housing loans – all the important parts of the banking system are doing well and we are not seeing any new developments. risk in any major segment when it comes to banking asset quality. Similarly, in terms of earnings and profitability, we are quite confident that the big players in the banking system will continue to deliver good earnings growth without asset quality shocks for some time to come. However, having said that, there are some concerns that arise regarding India’s macroeconomics today and since banking is a reflection of the country’s macroeconomics. So if there is a huge outflow from India due to any geopolitical or macroeconomic concerns, that will obviously impact the performance of the sector as well.

The biggest risk to us in terms of India’s macroeconomics today seems to be oil prices. If oil prices remain at this level above 100 or around 100 for another six, nine, 12 months, that will put additional pressure on both Indian inflation, Indian rates as well as trade deficit figures and that could lead to a macroeconomic downturn that could cause some impact on the fundamentals of the sector as well.

But so far, it’s a low probability risk and therefore every micro or macro sector we don’t see a big risk emerging in one of the segments we track.

Does the strengthening of the dollar really worry you?
Not so much the strength of the dollar but its impact on most emerging market currencies including India and the fact that this depreciation of the rupee is impacting a bit of inflation and the trajectory of interest rates is a bit of a concern.

We believe the Indian rate cycle will come to a halt only when the rise in the dollar slows down because until then, we may have to raise interest rates just to protect the currency. That is quite worrying because at some point, we want currency stability to emerge and depreciation to slow down. In recent months, we have seen sharp falls in the Indian currency and most emerging market currencies. India has outperformed most currencies but to that extent, in terms of outflows as well as the interest rate scenario, the strength of the dollar is a little worrying.

In 2015, 2018 and 2020, the sector gave poor returns. These funds are also very risky because of the concentration they have. How should investors view banking and financial services funds in the current juncture?
That’s a very difficult question to answer because the type of risk profile each investor has is quite different and sector or thematic funds are generally more volatile than diversified funds.

So one should know that opportunities in the financial services industry are expanding over the last few years like when we started managing or when I started managing financial services funds, at that time the options were limited to PSU banks, private. banks and one or two insurance companies.

Today the selection has expanded in the last 10 years to include several PSU banks, private banks, small finance banks, a large number of NBFCs, insurance, asset management and wealth management companies. And now new financial technology companies are emerging.

As such, the financial sector has become more diverse and perhaps less cyclical than it was a few years ago. So naturally, sectors and thematic funds will be more volatile in a diversified fund and therefore investors need to acknowledge that risk and see if it suits their risk profile or not.

Also in terms of duration, equity is a longer gestation asset and we always encourage investors to invest in equity for at least three to five years and that is true for sector funds, thematic funds as well as the minimum period of investment in equity assets should be medium term and at least at least three to five years.

In this scenario, well-diversified funds such as flexi-cap funds or large-cap funds have a lot of exposure to banking. So for investors to add this type of sector fund in their portfolio, what should be the criteria or parameters? How should investors play when they already have a diversified portfolio?
It is true that BFSI being the largest sector in the index and in terms of market capitalization in India, already has a significant presence in most diversified funds, and more so in large-cap funds compared to flexicaps, midcaps and smallcaps – perhaps for that matter. order. So having said that, there are one or two quirks of financial services that reflect the domestic economy.

In general the Indian banking and financial system is generally domestic in nature. If you want to increase your presence in the domestic economy in your portfolio, a financial services fund or an infrastructure fund is a good way to do it because most of the companies in these funds tend to focus on the domestic economy.

Obviously some of it depends on commodity prices and what happens in the global economy and inflows and outflows but generally the fundamental drivers behind most of the banking system in India are domestic in nature. That could be one of the reasons for investors to look at such funds in either banking or infrastructure.

Speaking of allocating exposure to this sector in your portfolio, what percentage of exposure should be given to banking and financial services funds?
That depends on the risk profile and the type of portfolio the investor is holding. If you are a slightly risk averse investor and your portfolio is more inclined towards large caps and balanced funds, then perhaps adding some beta in terms of either a financial services fund or an infrastructure fund is a good idea, given that India’s cyclical domestic economy looks quite strong and the sector this is a good picture of what is happening in India’s domestic economy.

But if you’re already heavily invested in slightly more volatile asset classes like small caps or sector funds, then it might not be a good idea to add more beta to that kind of profile. So it depends on the investor profile but I would say that investors should keep sector funds or thematic funds limited to maybe 20-25% of their asset allocation and not more than that.


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