The debate and research on active versus passive have shown that passive large-caps have done better as the scope for the active fund manager is limited to 100 stocks, whereas in small-caps, active management has done better as the fund manager has a wider scope. In the passive funds space – index schemes or exchange traded funds (ETFs) – several options are available.
You can either play it through the headline indices such as the Nifty 50 or Sensex, or you can participate in the large-cap oriented sectors that look promising. The dominant sector in Nifty 50 is financial services, with 35.6 percent weight. Within the segment, banking is the major constituent. There is a reason why financial services or banking is the dominant sector. As our economy develops, the sectors that contribute to the GDP and along with it to the stock market growth, the weightage assigned through market capitalization changes to reflect the new reality and expectations.
Nifty Bank’s outperformance
The Nifty Bank Index has delivered 17.6 percent CAGR on price terms (PRI) and 19.2 percent on total terms (TRI) between January 1, 2000 and December 31, 2021. Over the same period of 22 years, the Nifty 50 delivered 11.5 percent CAGR on PRI. Nifty Bank TRI has outperformed the Nifty 50 TRI in six of the last 10 years, from 2011-12 to 2020-21. The outperformance shows the relative importance and future potential attached by the market to the banking component of the headline index, which has contributed to the high weightage of the financial services sector. The Nifty Bank Index captures around 88 percent of the market capitalization of listed banks. There are 12 stocks in the Nifty Bank Index, of which 10 are private sector banks and two are PSU banks.
Now, the question is, if the Bank Index has outperformed, what is the investment thesis for the future? From the start of the COVID-19 outbreak in early 2020, the Nifty Bank Index has underperformed the broader market. From March 31, 2020 to December 31, 2021, the Nifty 50 has delivered a CAGR of 49.3 percent (PRI), whereas the Nifty Bank has delivered a CAGR of 42.2 percent (PRI). Though future returns are a function of multiple factors, as an indication, the price to earnings (PE) ratio of Nifty Bank Index was 22.3 as on December 31, 2021, against 24.1 for the Nifty 50. The price to book (PB) ratio of the Nifty Bank Index is 2.62, as against 4.37 for the Nifty 50, on the same date. The P/E ratio of the Bank Index is attractive now; it is at 22.3 now against 30.1 as of December 2020, 40.8 as of December 2019 and 54.5 as of December 2018.
Asset quality
The quality of assets of Banks, in terms of gross and net NPAs, has shown improvements in the challenging phase of the pandemic. Along with economic recovery, over a period of time, credit off-take from Banks would improve from the current muted levels. Lending rates, as and when the RBI reverses the interest rate cycle, would increase as well. The floating rate loans would be reset faster. For MCLR based loans, it would take time till deposit rates move up, but that will eventually happen. Fintech companies seem to be giving competition to banks and are threatening to take away business, but it is a “co-opetition” as fintechs do not have banking license.
How to take exposure
There are ETFs. You require demat and trading accounts with a stock broker. While ETFs also follow the designated index, there are index funds as well. In an index fund, you save on the brokerage / transaction costs that you would incur during the purchase / sale of ETFs. There are 10 funds that track the Nifty Bank, nine of which are ETFs and one is an index fund. Some of the ETFs are small in corpus size, which impacts the liquidity in the secondary market, as the potential buyers and sellers are limited. ETFs with large corpus size and consequently larger number of investors are Nippon India ETF Bank BeES, with a fund size of more than Rs 10,000 crore, Kotak Banking ETF (more than Rs 8,000 crore), SBI ETF Nifty Bank (just under Rs 6,000 crore) and ICICI Prudential Bank ETF (more than Rs 3,000 crore). There is a New Fund Offer (NFO) of the Nifty Bank Index Fund from Navi Mutual Fund, which closes on January 31, 2022.
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