Is it good time to invest in a banking and financial services fund? Find out

With investment climate improving and gradual opening of the economy post the 2nd wave of Covid, both retail and corporate growth are likely to improve hereafter.

HDFC AMC has come out with an NFO for retail investors – HDFC Banking and Financial Services Fund — which is open for subscription till June 25, 2021. The new fund aims to invest in the banking and financial services sector across segments and market capitalization, including, banking, broking, asset management, wealth management, insurance, non-banking financial companies (NBFCs), and other companies that may be engaged in providing financial services.

Anand Laddha, Fund Manager – Equities & Senior Equity Analyst, HDFC Asset Management Company Limited, in an exclusive interview with Sanjeev Sinha of FE Online, shares his views on whether it is an opportune time to invest in a banking and financial services fund, and what things investors should be mindful of while investing in a sectorial fund. Excerpts:

With the possible revival of economic growth, do you think it’s an opportune time to invest in a banking and financial services fund?

Over the last two decades the banking and financial services sector has grown faster than the GDP. Despite this growth in the past, the penetration of various banking and financial services in the Indian economy is low, which in turn means that there is a still significant growth potential in this sector.

In the last decade, the banking sector has been consolidating due to corporate asset quality challenges and weak private capex cycle. In our opinion, both the factors are possibly behind us. In the past few years, Gross and Net NPAs for the banking sector are on a declining trend and provision coverage ratio has also improved to over 70%. This indicates that banks have provided for most of the legacy NPAs and, going forward, provisioning cost is likely to fall. This was also reflected in the banking sector results for FY21 wherein incremental corporate stressed asset creation (slippages and restructured assets) was relatively low. This outcome on asset quality in a pandemic year gives confidence on the underlying strength of the banking system and corporate earnings.

Secondly, we are witnessing revival in corporate profitability of many sectors, especially capital-intensive sectors such as Metal, Cement, Pharma, Power, Textiles, etc.

Both these factors clearly reflect that the worst of corporate NPA cycle is likely behind us. In addition, most banks are carrying excess floating provisions, which should, to a large extent, take care of any asset quality challenges arising due to the pandemic.

To summarize, we are entering the cycle with strong banking balance sheet, comfortable capitalization level and adequately provided NPAs. Further, low interest rate environment, high liquidity and corporates balance sheets in good shape bode well for the sector. On top of that, technological advancement is not only resulting in higher penetration but also in lower cost of operations. This should also help in lowering the cost and customer acquisition. Thus, with investment climate improving and gradual opening of the economy post the 2nd wave of Covid, both retail and corporate growth are likely to improve hereafter.

What are the factors that will aid to the performance of banking and financial services fund over the long term?

There are many factors which in our view will aid to the performance of banking and financial services sector over the long term.

Firstly, GDP growth has bottomed out and the Indian economy should witness robust economic growth in FY22 and beyond, in our view, led by normalization of economic activity, pent up demand, favourable external environment, ample global and domestic liquidity. These are likely to be complemented by measures taken by the Government and RBI to revive the economy.

Further, Indian banks are in the best of shape after many years and we believe that capex cycle is likely to revive which should support credit growth. Also, corporate asset quality cycle is also largely behind us and the impact of pandemic has been limited due to lower restructuring and floating provisions.

Further, the pandemic has accelerated the pace of digital delivery of services compared to the pre-Covid period which is likely to drive costs lower. Besides, low interest rate environment and increasing awareness across sub-segments of BFSI business may also improve the penetration level and hence can result in the growth of the sector.

Finally, many new BFSI companies have aspirations to get listed over the next couple of years and, thus, can provide good opportunities.

What is your investment strategy around this fund?

The broad contour of strategy likely to be followed by the scheme is as follows:

# Multi Cap Strategy – The BFSI space offers depth and diversity of business to invest in. Scheme would invest across segments and market capitalization.
# Focus on Leaders – We will endeavour to invest in companies which are leaders and/or are gaining market shares due to superior execution, scale, better adoption of technology etc.
# Focus on Diversification / Low correlation – We will try to achieve effective diversification within the portfolio and manage risks by investing across sub-segments of financial services.
# Secular growth / Re-rating – We will endeavour to be equally focused on companies which are likely to

• witness steady and secular growth
• see a turnaround in profitability and have potential of being re-rated

# IPOs / New listings – We will also look at opportunities in new listings including pre-IPO participation

Do you think the valuations in the banking space are attractive enough for the investors to consider an investment?

In the recent rally, sectors such as information technology and healthcare were benefitted by the pandemic and have seen a sharp price appreciation. In comparison, banking stocks have delivered suboptimal returns. The sector currently is well placed to potentially benefit from revival in economic growth, in my view. Given the high linkage of the sector with GDP and low penetration, the sector could grow faster than the GDP with technology acting as a catalyst.

What are the various things investors should be mindful of while investing in a sectorial fund?

The scheme is suitable for investors:

# who want to create long-term wealth by investing in a sector which has a high correlation with the economy.
# who have an investment horizon of more than 3 years.

However, there are certain nuances which an investor should be aware of:

Firstly, performance of this sector, in particular, is closely linked to economic cycles and any downturn in economic cycles can impact the businesses and returns. Secondly, BFSI as a sector consists of leveraged businesses and is, thus, prone to asset quality issues. Lastly, evolving regulatory and technological changes can disrupt the business models.

However, weak asset quality cycle is largely behind us and outlook appears bright for the sector in my view. To reduce the risk, the scheme will focus on investing across sub-segments to achieve diversification and invest in companies which have demonstrated good track record with good quality management and are predominantly leading players in their respective business segment.

However, in general, sector funds carry higher risks. Thus, one should take controlled exposure to such funds.

Disclaimer: Views expressed herein are as of June 17, 2021, involve known and unknown risks and uncertainties that could cause actual results, performance or events to differ materially from those expressed or implied herein. HDFC Mutual Fund/AMC is not indicating or guaranteeing returns on any investments. Readers should seek professional advice before taking any investment related decisions and alone shall be responsible.