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Over the past year, the stock market has been on a bull run, so much so that finding value became a tough task. But as experts have pointed out often, banks as a space remained largely out of this frenzy and offered value, despite healthy business growth in the mid-teens. Though the sector has seen hiccups such as RBI’s risk-weight hike for unsecured loans and the current scramble for deposits, which remains an overhang on margin, the outlook remains positive, with the end of the banking cycle nowhere in sight in the medium term.
One way to play the sector is through sectoral mutual funds. Though there aren’t funds that invest purely in banks, there are funds that invest in the larger BFSI space that includes NBFCs, insurance and capital market companies, such as stockbrokers and AMCs. The Nifty Financial Services index is the benchmark for funds in this space. Over the past year, the index has yielded a return of 21.6 per cent, underperforming the Nifty 50, which has returned 26 per cent. Nevertheless, two funds from our Star Track Mutual Fund Ratings have bucked the trend and outperformed both their benchmark and Nifty 50, delivering 30 per cent plus returns. Incidentally, they happen to be rated with four stars. They are - Invesco India Financial Services Fund and SBI Banking and Financial Services Fund with returns of 35 and 32 per cent respectively (AUM of ₹1,043 crore and ₹6,407 crore respectively). Here we analyse the reasons behind their outperformance.
Diversification is key
The benchmark Nifty Financial Services index has 20 companies with a huge large cap tilt. Large cap companies make 94.9 per cent of the index, with mid cap and small cap accounting for 4.7 per cent and 0.4 per cent respectively. Whereas the funds in question have a more diversified exposure with mid caps and small caps constituting 18 per cent and 23 per cent respectively in the Invesco fund and 22 per cent and 16 per cent in the SBI fund respectively. The average return from a large cap stock that is/was part of the index or either of the funds over the past year is 34.4 per cent, while from a mid cap stock it is 89.6 per cent and for small cap 35 per cent. This is just to give a rough idea of how large caps have moved vis-à-vis mid caps and small caps, though portfolio weighted returns are the better way to analyse.
Similarly, banks constitute 76 per cent of the index, while they account for only 54 per cent of the Invesco fund and 59 per cent of the SBI fund. The two active funds have a larger exposure to insurance, NBFCs and capital market stocks. The average 1-year returns from a banking stock across the index and the two funds is 13.7 per cent, while it is 43.6 per cent, 52.9 per cent and 97.6 per cent for a stock from the insurance, NBFCs and capital markets space respectively.
Sluggish heavyweights
HDFC Bank, ICICI Bank, Axis Bank, SBI and Kotak Mahindra Bank make 75.5 per cent of the index portfolio. The 1-year return from HDFC, Axis and Kotak Mahindra are 10.6 per cent, 20.4 per cent and 6.6 per cent respectively, almost at par/below the 1-year return of the index. ICICI and SBI have returned 34 per cent and 43 per cent respectively.
As far as the funds are concerned, both have played it smart by being underweight on HDFC Bank. While the Invesco fund hasn’t had exposure to Kotak Mahindra Bank, the SBI fund hasn’t had exposure to Axis Bank. Though adding positions in Axis Bank over the year, the Invesco fund didn’t have a weightage higher than that of the index. The SBI fund on the other hand has been adding positions in Kotak Mahindra Bank and its weightage as of September 2024 is higher than that of the index.
Over the past 12 months, the weightage of ICICI and SBI in both Invesco and SBI funds have been fluctuating. On an average the weightage has been roughly the same as the index, with a minor 2-percentage points variance. However, the SBI fund has recently pared its stake in SBI bringing the weightage to 2.8 per cent as of September versus 7.5 per cent in the index.
Winners and losers
PFC, REC and Shriram Finance are the top 3 gainers in the index with 1-year returns of 92 per cent, 89 per cent and 79 per cent respectively. They continue to be part of the index at weights of 1.8 per cent, 1.7 per cent and 2.5 per cent respectively. Both the active funds have capitalised on the rally in these 3 stocks (Invesco only in REC) by being overweight when the stocks gained momentum and trimming stake to book profits.
For instance, as of September 2023, the weightage of REC in the SBI fund and the index was 1.7 per cent and 1.1 per cent respectively. The stock price then was ₹287.5. As the stock trended up to ₹499, the SBI fund added additional positions in REC such that the stock made 5.2 per cent of the net assets as of January 2024. REC’s weight in the index then lagged at 1.9 per cent. Over the months that followed, the fund booked profits and exited the stock completely in May, after realising higher weighted return relative to the index. Apart from the index stocks, both the funds have benefited from rallies in stocks like BSE, MCX, CDSL and PB Fintech.
Among the index losers with a weight of over 1 per cent, Bajaj Finance is the biggest with a negative return of 12.4 per cent. It continues to be a part of the index at a weight of 5.3 per cent. The two active funds though being overweight on the stock as of September 2023, have bitten the bullet and have exited the stock completely in Q4 of FY24 itself, after witnessing the underperformance.
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