Banking Funds – Definition, Advantages and Disadvantages
Last Updated : June 25, 2020, 6:59 p.m.
Equity funds can be divided into three categories based on investing themes-diversified equity funds, sector funds and thematic funds. Among these, sector funds are open-ended in nature i.e. you can buy/sell anytime, and they invest only in one particular sector. To know more about sector funds you can read another post of ours- https://www.wishfin.com/mutual-fund/sector-funds-are-these-a-good-investment/ . Banking funds are a type of sector funds, let us understand more about them.
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What are Banking Funds?
Banking funds are open-ended equity funds that invest only in the banking sector. The portfolio of these funds consists of both private and public sector banks. Private sector banks such as ICICI, HDFC, Kotak, Yes, IDFC, IndusInd, etc, are a part of the portfolio. Similarly, PSU banks such as SBI, PNB, Bank of India, Central Bank, Bank of Baroda, etc, are also a part of the portfolio.
There are some funds that are more diversified and invest in the financial services space, which would include banking, insurance, asset management and NBFC stocks. Since banks are the predominant player in the financial services space, a large part of the portfolio of these funds comprises banking stocks only. Thus, these funds are also classified as banking funds. The weightage between private and PSU bank stocks keeps changing in the banking fund portfolio basis the fund manager’s view on each.
What are the Advantages of Investing in a Banking Fund?
If you are bullish or positive on the banking space in India, you can invest in the banking fund. These are the advantages of investing in a banking fund:
Low Penetration – India is still largely an under-banked country with banking services not used by many Indians. Progress has been made in the last 5-10 years especially with Jan Dhan Yogna but we are still not there. This low penetration offers an opportunity for banks to increase reach, which will aid growth in the future. This will lead to banking funds doing well.
Credit Growth – The number of credit cards or loans availed by Indians as a % of the GDP is much lower than global numbers. This is bound to increase, and banks being the biggest lenders, will be the biggest beneficiaries. Also, lending is the major income source for a bank, so with pick up in credit growth, banks should do well, which will reflect on the returns from banking funds.
Size of Banks – Indian banks including the largest private and PSU banks such as HDFC and SBI are still small as compared to their global peers. With a rise in per capita income, these banks are bound to become bigger in the future which should enable banking funds to outperform.
Economic Growth – India has been among the fastest growing economies just before COVID-19 struck. It is poised to regain its growth sometime next year and banks will play a vital role in the country’s economic growth. Bank’s growth is directly proportional to the economic growth in the country. So, if you believe in the next 10-20 years the Indian economy will be among the fastest growing economies, banks are bound to be a part of this growth story.
What are the Disadvantages of Investing in a Banking Fund?
These are the disadvantages of investing in a banking fund:
High Risk – Banking funds being sectoral in nature carry a higher risk than other diversified equity funds. Since the fund is investing only in the banking sector and if this sector does not do well then returns will be severely impacted.
Cyclicality – Banking sector is cyclical in nature – it depends a lot on the economic growth and interest rates prevailing in the economy. When the economy is going through a downturn, banking stocks and banking funds do not do well since there is less demand for credit and deposits also fall. In a good economic scenario, banking funds will do well. If you have invested in the banking fund at the wrong end of the cycle, it could lead to losses on your portfolio.
Opportunity Loss – By investing a large part of your portfolio in banking funds, you will miss out on other sectors that are doing better than banking. These could be pharma, technology, consumer durables, infrastructure, power and others. This could be an opportunity loss for you, so it is better to be diversified and avail the benefits of best-performing sectors.
Asset Quality – Banks are prone to having asset quality problems every now and then due to indiscriminate lending and economic downturn. In such a scenario, banking funds will not deliver good returns. We are going through such a situation in the Indian and global economy right now.
Conclusion
When we look at the pros and cons of investing in a banking fund, on the balance it is better to avoid these funds. You get a reasonable allocation to the banking sector through a diversified equity fund, so you are better off investing in diversified funds. Also, diversified funds have the flexibility to invest in any sector and rotate among sectors. Presently, banking as a sector is under a lot of stress due to various reasons and banking stocks and banking funds have seen severe underperformance. The last one year average return for all banking funds is -28.8%, primary reasons being over-ownership, high NPAs and slow economic growth. We recommend avoiding banking funds for now. To know more about why banking funds are doing badly and should you invest now, you can read another post of ours- https://www.wishfin.com/mutual-fund/banking-funds-underperforming-should-you-invest-or-avoid/
