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Banking outperforms broader markets; time to exit? - Outside View by PersonalFN

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Banking outperforms broader markets; time to exit?
Mar 31, 2014

Banking stocks are buzzing on bourses these days. The sectorial indices tracking the movement of banking and financial companies are outperforming broader markets. Given the high weightage of the sector in diversified indices, even broader markets have benefited from rallies in financial stocks.

Has tide turned for the banking sector?
Data As on March 25, 2014
(Source: ACE MF, PersonalFN Research)

Till recently, investors were shunning financial stocks and equity diversified mutual funds were also cutting down their exposure to the banking sector. Banking funds were making losses for their investors. The sector was passing through a difficult phase. Banks were facing tremendous pressure of maintaining asset quality. Loans that banks sanction are their assets. When a borrower is considered to be incapacitated to pay interest and pay back the principal, the quality of assets of a bank is affected negatively.

Factors that affected the asset quality of banks include,

  • Higher inflation

  • Economic slowdown

  • Delay in getting administrative clearances

  • High interest cost
Having said this, banks have suffered from a weak credit evaluation and monitoring. Indian banks have restructured more than Rs 70,000 crore worth loans under Corporate Debt Restructuring (CDR) programme in 2013-14. There is a possibility of loans worth Rs 33,000 crore turning bad. Debt restructuring is an arrangement between a consortium of banks and the borrower. When business of the borrower is passing through turbulent times and generating enough cash to service the loan becomes difficult, consortium of banks may agree to alter terms of the loan. Sometimes, it is still difficult to recover loans. Recently, RBI raised concerns over deteriorating asset quality of banks, especially, that of public sector banks. The central bank also warned Scheduled and Commercial Banks about possibility of further deterioration in asset quality. On this backdrop, rally in banking and financial sector might look a little surprising.

What is driving banking stocks?0

Banking sector is cyclical in nature. When the economy is growing at a slower pace, the sector is negatively affected but when economic cycle turns, banking sector sees rapid growth. Until few months back economy was growing at sub-5% level, inflation and interest rates were also high. Apart from that, there were whopping 301 projects with investment of more than Rs 150 crore each were awaiting clearances. As far as inflation is concerned, it has started falling. Although there are still some upside risks, retail inflation as measured by the movement of Consumer Price Index (CPI) fell to 25-month low in February. RBI is unlikely to reduce policy rates due to which borrowing cost is likely to remain high.

However, the market sentiment has been upbeat as pre-election surveys suggest that BJP-led NDA is likely to form the new government. Investors believe that BJP led government would bring in more efficiency in governance and help avoid bureaucratic red tape which has been one of the biggest reasons for poor industrial performance in last few years. Markets are hopeful that the new government will introduce new reforms to get the economic growth back on track. Market believes once the growth picks up and asset quality problems are resolved, banking sector would witness substantial improvement in performance. Some big honchos in banking sector are optimistic that worst might be behind us and asset quality may start improving hereon.

Have mutual funds benefited from the current rally?

Banking sector was out of favour for considerable time at the beginning of the on-going rally. Taking a contra call on the sector, Foreign Institutional Investors (FIIs) started buying aggressively which was followed by selective buying of mutual funds. It is noteworthy that, despite asset quality concerns, mutual funds have picked up stocks of a few public sector banks and have also favored some large private sector banks.

How banking sector funds have performed?
  Returns (Absolute %)
  1 Month 3 Months 6 Months 1 Year
Category average of banking sector funds 14.5 7.6 22.4 8.1
Category average of opportunities funds 5.9 5.1 17.1 19.9
S&P BSE BANKEX 16.7 9.9 23.8 11.3
S&P BSE 200 6.3 4.3 12.6 15.7
S&P BSE SENSEX 5.8 4.9 11.1 18.1
Data As on March 25, 2014
(Source: ACE MF, PersonalFN Research)

Table above suggests that, as a category, banking funds have underperformed, S&P BSE Bankex over last 1 year. The category average returns of banking funds have been higher than those generated by opportunities funds over last 1, 3 and 6 months. However, as far as returns generated over last 1 year are concerned, opportunities funds have outperformed banking funds.

What should investors do?

Markets may remain strong at least till outcome of election is known. Depending on the election results, markets may decide upon their future course. If the mandate is strong, they may continue to remain upbeat but a fractured mandate may disappoint them. Valuations are not cheap at the moment, which gives lower margin of safety in case of any unforeseen market gyration.

PersonalFN has always been of the view that, investors should avoid sector funds. The possibility of generating superior returns through sector funds requires timely entry and exit. PersonalFN believes, investors shouldn’t bet on market momentum and stay away from banking funds. In case anyone of you has invested in a banking fund; current levels provide good exit opportunities. You may consider investing in a consistently performing opportunities fund. Diversified nature of opportunities funds make them less risky than sector funds. If chosen carefully, opportunity funds can help you capitalise on opportunities present across sectors.

PersonalFN is a Mumbai based personal finance firm offering Financial Planning and Mutual Fund Research services.


The views mentioned above are of the author only. Data and charts, if used, in the article have been sourced from available information and have not been authenticated by any statutory authority. The author and Equitymaster do not claim it to be accurate nor accept any responsibility for the same. The views constitute only the opinions and do not constitute any guidelines or recommendation on any course of action to be followed by the reader. Please read the detailed Terms of Use of the web site.

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