The variety in banking and financial sector mutual funds and which one to pick

banking sector funds

DSP Mutual Fund announced the launch of open-ended exchange-traded funds: DSP Nifty Private Bank ETF and DSP Nifty PSU Bank ETF. The new fund offer of Mirae Asset Nifty Bank ETF closes on July 18. The new fund offer of Bandhan Financial Services Fund is open till July 24. Fund houses have launched new schemes focussed on the banking, financial services and insurance (BFSI) sector. The plethora of choices may be confusing, but investors need to understand what they are buying and not focus on past returns.

BFSI – a large sector

The BFSI sector houses some of the largest listed companies in India. It is the backbone of the Indian economy. With rising acceptance of financial products by various segments of the economy – broadly known as financialisation – companies in this sector have grown with increased digitalisation. Given the low penetration of financial services, the sector has a long growth pathway. The sector has three key segments – lenders including banks and non-banking financial companies, insurance companies, and financial services companies including brokerages, exchanges, asset management companies, depositories, and registrar & transfer agents. Each segment has different growth drivers and enjoys valuations accordingly. Public sector banks are seen as cyclical investments as they tend to do well when capital expenditure in the economy catches up, which is happening now. On the other hand, companies in the financial services and insurance sub-sectors are more long-term structural stories wherein shareholders bet on their wider presence among the masses amid economic growth and development.

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Product for each segment

While the sector has growth drivers in place, investors must identify the right scheme depending on their views. Before getting into the details of each segment of schemes, you should know that you won’t miss anything even if you don’t allocate money to these sector funds because most diversified equity funds have exposure to the BFSI sector. Multi-cap funds and flexi-cap funds as categories had 22.71 percent and 28.61 percent exposure, respectively, to BFSI, as of June 30, according to Value Research. Fund managers keep changing their allocations to segments within the BFSI sector depending on their relative attractiveness. In June, mutual funds invested in NBFC stocks while booking profit in private banking stocks.

If you have a positive view on the BFSI sector or a certain segment and you are keen to enhance your investments, then you should allocate money to these BFSI sector funds. Of course, you have to make following choices:

Active or passive?

At a sector level, you may invest in an index fund or an exchange traded fund (ETF) that tracks Nifty Financials TRI, which offers exposure to banks, NBFCs, insurance companies and other financial services companies. If you believe that a fund manager can take advantage of the relative attractiveness of stocks and build a portfolio that beats the index, then you can invest in an actively managed fund as well. ICICI Prudential Banking and Financial Services Fund, the largest among BFSI sector funds, is an actively managed fund with assets under management of Rs 6,961 crore.

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However, if you are keen on a specific sub-segment of the BFSI sector, then you have Nifty Bank TRI, Nifty PSU Bank TRI and Nifty Private Bank TRI, which follow the performance of stocks of banks, public sector banks and private sector banks, respectively.

Many savvy investors complain that most market capitalisation-based products allocate large weights to banks, given their size. This means smaller financial services entities would get less weight in the index. The Nifty Financial Services Ex-Bank TRI addresses this issue. This is an index comprising financial companies including financial service providers and insurers. But it does not allocate money to stocks of banks. ICICI Prudential Nifty Financial Services Ex-Bank ETF tracks this index.

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To invest in stocks of financial companies excluding banks, another alternative is Motilal Oswal S&P BSE Financials ex-bank 30 Index Fund. Both these schemes were launched in the past one year and have a limited track record.

Are they attractive?

“The financial services sector is agile in embracing new businesses and themes that could further enhance its growth prospects,” Sumit Agrawal, fund manager, said at the launch of the Bandhan Financial Services Fund. “With a whole host of sub-segments and a solid track record for wealth creation over the long term, the valuation of the Nifty Financial Services Index is currently at reasonable levels, a relatively attractive entry point for investors looking to benefit from the growth prospects of this diversified sector.”

DSP Mutual Fund, in its recent monthly report titled NETRA – Early Signals Through Charts July 2023, expressed its constructive stance on NBFCs. “During a downward rate cycle, wholesale funded entities like NBFCs benefit the most from a significant decline in the cost of funds. Additionally, their limited exposure to external benchmark-linked loans drives better spreads, leading to improved profitability. Faster growth, market share gains, and improved margins contribute to higher earnings growth, making a case for multiple re-rating, similar to the thesis for banks in 2022-23,” it said.

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Looking at the plethora of products, you may wonder where to invest. Jignesh Shah, founder of Mumbai-based Capital Advisors, has a simple solution. “Relatively clean balance sheets and an expanding economy are a good combination for growth in banking. Investments in banking stocks also fetch exposure to high-growth financial services such as insurance, broking, asset management among others, as many large banks such as SBI, HDFC, ICICI, Kotak offer these services through their subsidiaries,” he adds.

Savvy investors may find financials a proxy for the Indian economy and may want to take exposure to a specific segment of the financial theme or may want to hand over their money to a fund manager seeking more returns than offered by an index.

Whichever route you choose, to make money like in any other sector fund, you have to get the entry and the exit right.