Why Roshan Chutkey of ICICI Prudential MF thinks a K-shaped economic recovery will benefit banks

The COVID-19 pandemic has led to stress in the banking sector. But Roshan Chutkey, fund manager, ICICI Prudential Banking and Financial Services scheme is not disturbed. He says bank funds are cyclical. Speaking to Vatsala Kamat, Chutkey, who is optimistic on India’s economic recovery, discusses why he is comfortable betting on the larger banks. He also suggests ways for investors to ride the banking sector cycle.

Your top four holdings account for half the portfolio and are frontline banks. Is it not risky given the stress in the sector due to the pandemic?

We are seeing a K-shaped economic recovery from the pandemic. The upper hand of ‘K’ is represented by large and mid-sized corporates, which have healthy cash flows and strong balance sheets. The lower hand is represented by micro, small and medium-sized businesses (MSMEs) that are in distress right now.

The top four stocks in our portfolio service the resilient part of the economy. Besides, their balance sheets carry adequate provisions to shield from any potential stress that could emanate from the lingering impact of the second wave.

Some investors argue that a BFSI scheme is more all-weather than other thematic funds. Do you agree?

A BFSI fund is a cyclical scheme. It’s best for small investors to invest through a systematic investment plan (SIP) instead of trying to time the cycle. Timing the cycle is a fund manager’s job.

At present, the banking sector is transitioning from an early recovery phase to the mid-cycle. But I sense that it may be bumpy since economic recovery is yet to trickle down to the MSMEs. For this, the government spending has to increase, which will eventually nudge private sector capital expenditure. Exports must support, which is possible given that developed economies are on the road to recovery.  If  these two elements fall in place, the banking cycle will be on a stable growth path. I am optimistic we are heading there.

Some fund managers believe that fee-based financial services are better-placed than banks with corporate lending focus, at this point. What is your view?
We have a significant exposure to such fee-based financial services firms compared to the benchmark indices. But valuations are important. At this point in time, non-lending businesses are fully valued in many cases. So, I wouldn’t take fresh exposure to this segment. On the contrary, lending businesses still have reasonable upsides in spite of the rally we have seen.

Do you believe that there would be more mergers among banks?
Acquisitions are best done when valuations are suppressed or companies are liquidity starved. At this point in time, neither is the case. Well, there could however be M&A activity triggered by priority sector lending needs or in pursuit of a banking license (there are enough number of PSU bank targets).

What are the biggest risks to the banking and financial services sector?

The main risk is deterioration of the business cycle. This could be because of exports not taking off, or lack of bank funding to MSMEs, or even the US Federal Reserve turning hawkish ahead of expectations, which may lead to US dollar appreciating. In turn, it may lead to tight liquidity conditions, which can cause serious problems as we are just getting out of a weak economic cycle.

But I believe that the probability of this risk playing out is low. I expect a confluence of monetary plus fiscal support to continue, which will help us emerge out of the pandemic stress. I would not alter the portfolio at this point. It is positioned to wade through the known unknowns.What kind of downside protection is there in a BFSI sector fund for an investor?

For a cyclical fund like this, understanding the macroeconomic cycles is very important. The capability of the fund manager to spot signals of change in the cycle determines the performance of the fund.

For an investor therefore, it is not advisable to invest lumpsums in such sector funds. A BFSI fund is like the central nervous system of the economy, but it is best to participate through a systematic investment plan. I think an investor can have 8-10 per cent exposure to a BFSI fund within the equity basket. This is assuming that he/she has diversified equity funds in the portfolio, which also have an exposure to this sector.

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