To market, to market, to buy a lean bank
For those of you who believe that the economy may be turning the corner, a high beta sector such as the banking and financial services sector could be the one to look for some high performance.
With a return of 23% compounded annually in the last 5 years, the CNX Finance Index has comfortably outpaced the CNX Nifty by over 5 percentage points. That said, the banking sector is also often the worst hit in economic downturns and market falls.
It is perhaps sensing opportunity in the financial services sector, in its beaten down condition now, that Birla Sun Life AMC has chosen to launch its new fund – Birla Sun life Banking And Financial Services – an open-ended theme fund that will invest in banking and finance stocks.
Case for Banking Sector
Plagued by tight liquidity, prolonged periods of elevated interest rate and lower capital investment by companies besides higher non-performing assets, banking stocks have taken a knock in the past year, thereby leading to their valuations trading at below long-term averages. The data below shows that each category – public sector banks and private sector banks, are trading well below their averages. NBFC stocks too are trading at 1.7 times their Price to Book Value, lower than the average of 2.2 times in the last 8 years.
Still, unlike many sectors such as real estate or infrastructure, which hold vulnerable balance sheets that can topple without much support, the banking sector has been governed by prudent provisioning norms by the RBI, ensuring better transparency and fewer shocks.
While there could be no near-term remedies and rates could remain elevated in the short term, it appears that corporate yields have already priced in high rates. Hence, when rates do ease over the medium term, deleveraging of corporate balance sheets could put less pressure on the banking system.
Besides, there also appear a few reform triggers in sight for the sector to leap to the next leg of growth. They are:
- Risk weights for housing finance companies reduced, thereby freeing up more cash for lending
- New banking licenses from 2014
- IRDA allows insurance sector to take higher exposure to housing finance companies
- Foreign banks to be allowed to enter India and takeover domestic lenders
- About 1.5 lakh crore worth of infrastructure projects cleared, thus providing trigger for corporate investment cycle
That said, higher inflation and continuing high interest rate scenario could put pressure on banks’ balance sheets which are currently under stress. Requirement to adequately capitalise themselves on Basel III norms could only add to the pressure. These, therefore, remain risks to taking exposure to the sector at this point.
The Indian banking and finance space, including NBFCs and brokerages, has over 150 stocks to choose from with a total market cap of 1.5 lakh crore. Hence, unlike the limited options in other sector/theme funds, the finance sector offers sufficient scope for diversification. Currently, banking funds from Reliance, ICICI Pru Mutual, Religare Mutual and UT Mutual, to name a few, have all crossed a five-year record and generated over 20% returns, compounded annually in the last 10 years.
While there are banking ETFs as well, they have generated lower returns than actively managed banking and finance funds as ETFs do not take exposure to the non-banking space.
It is noteworthy that non-banking companies with exposure to housing, consumer finance and rural finance have generated exceptional returns in the past few years and continue to show strong growth. Stocks such as Bajaj Finance or Mahindra Finance are examples of re-rating stories in the market.
Investors may note that the banking and finance sector can help boost portfolio returns in an upturn, and can equally hit a portfolio during a downturn. Hence, exposure to this sector fund needs to be restricted to less than 10%. An active profit booking strategy may be needed, especially when the banking index outperforms bellwether indices by say over 10 percentage points.
Birla Sun Life Banking and Financial Services Fund itself levies an exit load for investments redeemed within 2 years; hinting that it is not meant for short-term holding.
The fund will be managed by Satyabrata Mohanty and will be benchmarked against the CNX Finance, a fairly concentrated index. The new fund offer closes on December 9, 2013.