Banking mutual funds turn sour; what’s the outlook for them amid the global turmoil?

The Indian banking sector, hurt by a foreign investor selloff triggered by dislocations such as the collapse of Silicon Valley Bank (SVB) and the takeover of Credit Suisse by UBS, offers investors a buying opportunity thanks to the drop in stock valuations, experts say.

As a category, banking mutual funds have delivered the worst returns at -9.13 percent since the start of the year, data available with Value Research shows. The category delivered a more than 21 percent return in 2022.

To be sure, fund houses have variations of banking sector funds; some focus on private sector banks, some on public sector banks and others invest in both as well as financial companies. Some schemes are actively managed and some passively managed.

The Indian banking sector performed well last year with an uptick in loan growth, a sharp, sequential net interest margin (NIM) improvement, and continued reduction in stress levels. Improvement in asset quality was led by lower slippages and relatively stable recoveries or upgrades.
Also read | Diamonds in the dust: Favourite midcap stocks of MF and PMS that hit 52-week low

Let’s take a look at what’s ailing the sector, the global setup and how mutual fund investors can navigate the market during this phase.

Global banks on a shaky ground

Two US banks, Silicon Valley Bank (SVB) and Signature Bank, were ordered to cease normal operations recently because their liabilities far exceeded their assets.

Switzerland-based UBS agreed to acquire troubled rival Credit Suisse in a government-backed deal at a discounted price of $3.2 billion.

Aggressive interest rate increases and tightening of liquidity have taken a toll on banks in the US and Europe.

The current banking crisis, especially at Credit Suisse and a few US-based banks, is likely to trigger some regulatory measures across the global banking system.

Experts say auditing and financial reporting may become more stringent and rules to address liquidity and duration risk stricter. After the financial crisis of 2008, regulatory changes put more emphasis on credit risk. The latest crisis is exposing other risk factors like liquidity, duration and market risk.
Also read | What message will the US Fed have for Indian investors?

“We expect the regulators and external auditors to be proactive to safeguard shareholders' wealth,” said Ajit Kabi, banking analyst at LKP Securities.

The India story

Optimists had hoped that global dislocations would not impact Indian banks, but data shows otherwise. India’s biggest banking fund, Nippon India ETF Nifty Bank BeES, has slumped around 9 percent on a three-month basis.

“All the markets are extremely interconnected, and coming from the 2008 crisis, we know that all of these banks are so interconnected. We don't know who has got a derivative play on what instrument and which Indian bank has actually bought it. It is just the fear of unknown which is creating the panic,” said Kirtan Shah, founder of Credence Wealth Advisors LLP.
Also Read | Check out Moneycontrol’s curated list of 30 investment-worthy mutual fund schemes

Another reason for negative sentiment on banks is selling foreign portfolio investors (FPIs). Data from the National Securities Depository Ltd. (NSDL) showed that FPIs have sold around Rs. 26,255 crore worth of stocks in the Indian equity market since the start of the year.

“Indian banks are falling because of the FPI selling pressure. Foreign investors have very large positions in banks such as HDFC, ICICI, Kotak Mahindra, and even SBI (State Bank of India),” Shah said.

What should investors do?

According to Rushabh Desai, founder of Rupee With Rushabh Investment Services, banks' valuations have become attractive. “Private banks’ price-to-earnings and price-to-book (as on February 28) has fallen by 27% and 4.8% respectively from their 10-year average. I am betting more on the private banks as PSUs (Public Sector Undertakings) have government controls,” he said.

Public sector banks are trading at a premium compared to their 10-year average, but this is on a low base.Also read | Top 5 credit cards for international travel

Jefferies India, in a recent note, said the valuations of Indian banks were looking fairly attractive and, in some cases, stocks were trading below their levels at the height of the Covid-19 pandemic.

Even Desai suggests that investors may enter the banking sector because of the attractive valuations.

And the failure of two US banks and the banking crisis in Europe may have no material effect on the earnings outlook of publicly traded Indian companies.

According to experts, prior to the recent dip in banking funds, the sector had been experiencing decent credit growth.

“From a three-five-year perspective, every dip in the banking sector is a great buying opportunity. Looking at the current situation, if things stabilize globally for banks, this will turn out to be a great opportunity to buy,” said Shah.

Experts, however, warn that there could be more room for a correction if things get worse for the global banking sector.

Keep in mind that in sectoral funds, an investor needs to time the entry and exit correctly.

Also, most large-cap and flexi-cap schemes have the largest allocation to the Banking, Financial Services and Insurance (BFSI) sector. If you are already invested in these and do not have a view on the sector, then you can skip these sectoral funds altogether.