From the turn of the century, the industry has been growing at 20 per cent per annum. And it is estimated that in the coming years, Indian banks are expected to grow at 35 per cent per annum.
In a growing economy, this sector is a direct beneficiary. What's even better is that its net non-performing assets (NPAs) have come down considerably from 8 (in the year 2000) to 1 per cent today.
To fund this growth, banks would need funding to the tune of $14 billion. This is one of the reasons the Reserve Bank of India (RBI) is opening up the sector to foreign players next year. From 2009 onwards, foreign banks would be allowed to acquire up to 74 per cent of any Indian bank.
The domestic players will benefit from the essential capital and expertise while the foreigners would get a foothold into this lucrative sector (for new players) and have the ability to reach a larger audience (for the existing ones).
In recent times there has been considerable investment by international banks like Citigroup, HSBC, Bank of America and Deutsche Bank to scale up their operations in India. Moreover, foreign institutional investors (FIIs) are also betting on this sector. As many as five public sector banks (PSB) have exhausted their limit of FII investment, with three more along with four private sector banks in the caution zone.
The only way out for FIIs is to now tap the banking exchange traded funds (ETFs) and sector funds focussed on the banking sector. This could explain why in the past 12 months the average monthly growth in the units of equity banking funds has been around 24 per cent.
At present, there are three open-ended equity banking funds in the market, while another two should be available for investment soon. Four more are still in the approval stage. But each of the existing three have their own character, the similarity begins and ends with the common sector.
Their investment strategy, market cap preference, choice of scrips and type of stocks vary. And these banking sector funds don't have a mandate limited to pure banking players. Financial institutions and brokerage stocks also find a place here.
While we look at the three equity funds in our analysis, there are also three ETFs available for investment. Like its cousins in the equity category, the Banking BeES, the largest ETF has rewarded its investors by giving a return of 36 per cent since inception.
So if none of the equity funds appeal to you, you could even look at this option. All said and done, this sector deserves a presence in any portfolio.
JM FINANCIAL SECTOR FUND – UP AND DOWN
The newest entrant to the pack got itself noticed in the very first year of its existence. Though it trounced the competition in 2007, its performance was not consistent all the year through. And while investors celebrated with a 95 per cent return in 2007, in the March 2008 quarter they had to grapple with negative returns of 33.36 per cent.
It can be argued that the fall was the logical outcome of the entire sector plummeting and the market going downhill, but JM Financial fell harder than its peers (Reliance fell by just 22.26 per cent).
This fund has always been very bullish on ICICI Bank. Soon after launch, this scrip cornered 32.49 per cent of the portfolio. It is the only stock in the portfolio that has been there continually since launch. Even now, it is the top-most holding at 11.57 per cent.
The fund manager chases growth so momentum stocks like Reliance Capital, Indian Infoline and Srei Infrastructure are more favoured than stocks like Bank of Baroda, Corporation Bank and Federal Bank which are prominent in the portfolios of the other two funds. It has more or less avoided public sector banking stocks like Maharashtra Bank, Jammu & Kashmir Bank and South Indian Bank.
Though the fund manager continuously held on to stocks like ICICI Bank, HDFC Bank, Yes Bank, IDFC, PFC and Mahindra & Mahindra Financial Services for fairly long periods of time, it does not indicate that he adheres to the buy-and-hold strategy. He has entered and exited stocks like Axis Bank, Bank of India, IDBI, Karnataka Bank, Kotak Mahindra Bank and
Reliance Capital only to once again get into them at a later date. Of course, the small size of the fund has given the fund manager the leeway to be a nimble player.
This investing style of chasing growth and selling once a price objective has been achieved, only to re-enter later, is typical of fund manager Sandeep Neema.
But what's also typical is that when his fund outperforms, it is streets ahead of the competition, but when it does not, it falls much lower than its peers. If you are considering this fund, get mentally prepared to ride the ups and downs.
RELIANCE BANKING FUND – STEADY RETURNS OVER TIME
As the oldest and largest banking sector fund, it has not disappointed investors. Over the past five years, it has delivered an annual return of 42 per cent. Historically too, this fund has been less volatile than its peers or its underlying index.
Despite being a good performer, the fund took second place to JM Financial in 2007. In the December 2007 quarter, Reliance Banking delivered 19.43 per cent as against 28.52 per cent of JM Financial. But in the following quarter (March 2008), Reliance Banking fell by just 22.26 per cent, as against JM Financial's fall of 33.36 per cent.
The reason was two-fold. Reliance Banking stayed away from high PE stocks — Axis Bank, HDFC Bank, Yes Bank, Cholamandalam DBS Finance and Srei Infrastructure. As a result it lagged in 2007 but fell much less when the market tanked.
Reliance Banking's high cash component also proved to be a buffer when the market fell. Like all the sector funds from Reliance AMC, this one too has the leeway to go fully into cash, should the need arise.
While it has not exercised that option, it does have the tendency to hold larger cash positions than its competitors. Its cash component had consistently increased from 14.52 per cent (November 2007) to 32 per cent (February 2008). Since January 2008, it has averaged at around 25 per cent.
In March 2008, when the prices fell and valuations looked to be more reasonable, the fund manager picked up Axis Bank and Kotak Mahindra Bank which he avoided earlier because they were too expensive.
What's interesting about this fund is its penchant for broking stocks — India Infoline, Indiabulls Financial Services, IL&FS Investsmart and Motilal Oswal Financial Services. But financial institutions stocks like IDFC and IFCI are not courted.
What we like about this fund is its consistency. The fund manager's strategy may not deliver headline grabbing returns but it has led to a solid record over the long haul.
UTI BANKING SECTOR – IN LINE WITH INDEX
UTI Banking Sector has been, by and large an average performer.
Fund manager Gautami Desai has not been an opportunistic investor and prefers to invest in large banking stocks. This fund has avoided brokerage stocks and prefers financial institutions like Power Finance Corporation, LIC Housing Finance and IDFC.
This strategy has certainly not resulted in the fund shooting out the lights and last year it was behind its peers in terms of returns. And what was even more disappointing was that in the recent bear run it fell by 30.16 per cent, compared to Reliance Banking Fund's -22.26 per cent and JM Financial Services -33.36 per cent returns (March 2008 quarter).
What's amazing is that when UTI Banking Sector is compared to a banking exchange traded fund Banking BeES - there has barely been any addition of alpha. The two-year annualised returns are around 32 per cent, while Banking BeES delivers a higher three-year return. So logically, why would an investor pay 2 per cent more as annual expenses (with this sector fund) when the return is virtually identical?
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