Mutual Fund Category Analysis Banking Sector Funds

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1 November 18, 2014 Mutual Fund Category Analysis Banking Sector Funds Key Facts: What are they? Banking Sector funds are equity oriented schemes investing predominantly in the banking stocks. Banking Category: There are 13 schemes including 4 ETFs coming under this banking category. Amongst, two ETFs named, GS PSU Bank BeES and Kotak PSU Bank ETF are investing predominantly in Public Sector Banks while the others either expose majorly into private sector banks or balancing the assets among the stocks of public and private sector banks and financial institutions. Like other Sector funds, banking sector funds are also high risk high return funds. Concentrated investment approach makes these funds more risky than diversified equity oriented funds. Banks as a sector is a high beta sector; in the sense that it rises and falls more than the Nifty/Sensex. Suitability: These are suited for high risk profile investors who are well-versed with the stock market and understand the sectors and their moves. Banking industry: Banking industry is one of the key drivers of a nation s economy and its growth is dependent on the overall growth in the economy. It plays a significant role in the development of trade, commerce and industry of a nation. Sector Funds: Equity Sector funds are riskier categories among the equity oriented mutual funds, as they follow concentrated investment approach of investing in a particular sector. The performance of the sector funds are cyclical in nature and sensitive to change in their respective sectors. They have managed to deliver good returns in times when their respective sectors or industries performed well. Performance: Overall Banking sector category showed above average returns in comparison to the other equity oriented categories. Performance based on rolling returns calculated for last 7 years shows the outperformance of the banking category against its peers in the six month periods but posted average returns in one, three and five years periods. Considering the performance during various cycles, the banking category rose the most during bull runs and fell the least during bear runs. The performance during volatile periods was also not commendable. However, schemes specific returns are commendable from the category as the schemes like ICICI Pru Banking & Financial Services fund, Reliance Banking fund, R* Shares Banking ETF and GS Bank BeES have delivered better returns over short term as well as long term periods. Portfolio: All the schemes from the category prefer to hold maximum assets in Private sector banks (except GS PSU Bank BeES and Kotak PSU Bank ETF as they are mandated to invest only in PSU Banks). HDFC Bank, ICICI Bank, SBI, Yes Bank and Axis Bank are the top 5 holding placed in the category portfolio (as per the latest data of Oct 2014). As far as sector allocation is concerned, about to 60% of assets are kept in private sector banks. However, the latest portfolios of the category show an increased exposure into the shares of Finance & Investments companies. No entry load is applicable while investing in these funds. The Exit load is charged ranging from 1-2% for the redemption period of 1-2 years. However, no exit load is applicable for Banking ETF but transaction charges are applicable.

2 Equity Sector Funds: Sector funds are high risk high return funds. They are more risky than diversified equity oriented funds. Diversified equity funds mitigate the downside risk by diversifying their portfolios across sectors, while the sector funds are exposed to higher risk as they are narrow in terms of asset allocation on particular sector. Further, diversified equity funds have the leeway not only to pick the best performing and growth sectors but also to remove poor performing sectors. On the other hand, sector funds invest only in the sectors as mandated and adhere with the objective irrespective of any market conditions. Even though sector funds have a potential to fetch better returns compared to other equity oriented funds based on developments in the sectors, one cannot expect consistent returns over periods since their investment strategy hovers within a limited sphere. The performance of the sector funds moves in cycles. Every cycle will have a new out-performer and an under performer. For example, the Information Technology sector was at peak while compared to other sectors during the year But it was seen at the bottom during The sector came to the top slot in 2009 again. Likewise, was the best performing period for infrastructure industry. They turned bottom performer for the next four years. The banking sectors outperformed during 2009 but underperformed in Hence, the performance of these funds is linked to the fortunes of the sectors. The funds do well if the respective sectors perform well. Interestingly, some of sector funds over the long run outperform even the diversified equity funds. The below chart proves this fact as the sector categories such as FMCG, Pharma and Banking delivered better returns for the three and five year time frames than diversified equity category. Banking Sector: Banking industry is one of the key drivers of a nation s economy and its growth is dependent on the overall growth in the economy. It plays a significant role in the development of trade, commerce and industry of a nation. The banking sector in India stands on strong foundations of prudent policy framework laid by the regulators. This excellence has been proved in a scenario where the Indian banking industry managed to overcome all the headwinds from the global financial turmoil when the U.S sub-prime mortgage crisis occurred which resulted in bankruptcy and/or writing-off debt by some of well-known global banks. In the last decade, Indian banks and financial services companies have not only expanded their client base but have also brought in efficiency in their operations which results in better quality of services. Public sector banks have been proactively restructuring their balance sheets. There has been steady consolidation in retail lending and demand for credit has increased. Banks focus on low-to moderate risk segments and the increased diversification in their loan portfolios should help maintain their asset quality. The banking sector remains a favorite for a majority of equity funds. The following is the chart showing the deployment of funds by the whole equity MF industry among sectors. Banking sector has been in the first position over times.

3 Exposure to Sectors by the Mutual Fund Industry (Top 20 sectors): Banking stocks have been the most preferred options for the mutual funds over periods: Banking Sector Outlook: Since the performance of the banking sector rely mostly on the overall growth in the economy, the efficient policy actions taken by the new progressive government to pave the way to the sustainable growth of the domestic economy which would result in appreciation in the prices of the banking stocks. The banking sector saw facing a lot of issues in the recent past like non-performing assets (NPA), exposure to sectors like aviation, power, infrastructure etc. Weakening asset quality and credit concentration build up were also putting pressure on the downside. The focus on the development of the infrastructure industry by the new government would benefit the banking sector going forward seeing the improvement in their loan books. The new initiatives from the RBI like recent revision in liquidity guidelines under the Basel-III framework, issuance of new banking licenses are expected to boost the banking sector. The issuance of new banking licenses will expand the banking industry with more innovative ideas. The increase in the FDI in the banking sector would help more inflows into the banking sectors. The RBI s recent reluctance to cut the policy rates may somewhat impact negatively to the banking sector. However, the expectation of rate cut in the next 3-6 months to augur well to the sector. It is worth noting that the recent amendments made in the Union Budget 2015 by the Finance Minister Mr. Arun Jaitley in the tax implications of the Debt mutual funds by removing the tax arbitrage between Debt mutual Funds and Bank FD is also to favor the banking sector to improve their deposits growth.

4 The performance of the banking sectors seems to be improved in going forward. The non-performing assets are under control. Credit and deposit growth are expected to improve with the expected development in the infrastructure sectors on the back of the government s initiatives. Experts believe that the banking sector will create more jobs in the next 5-10 years due its growing business demand. The banking sector is likely to perform well and play an important role in India growth story in the following years. The banking sector is likely to see healthy growth over the long term due to the initiatives taken from the regulators and governments, rise in rural incomes, increased spread of banking services and considerable credit offtake. Rate cute to factorize positively to the banking sector: Deposit & credit growth in commercial banks over periods:

5 Banking Sector Funds Vs. Other Equity Oriented categories: Category Performance (based on Rolling Returns): Category 6 Month Absolute 1 Year 3 Year 5 Year Banking FMCG IT Infrastructure Pharma Equity Diversified Category Note: NAV values are as of Oct 30, Top 2 performers are highlighted by yellow. Returns are rolling calculated from the last 7 years NAV history. Banking Sector Funds Vs. Other Equity categories in various cycles: Risk Parameters: Standard Deviation & Beta: The above chart shows that the Banking sector category posting outperforming returns during equity Bull Runs. However, the category fell sharply among the equity oriented categories during bear runs. The chart further reveals that the category generates least returns during volatile and uncertain market conditions as they are more sensitive to the macro economic conditions and generate high beta against the broader markets. As seen in the above chart, the highest Standard Deviation (calculated based on the daily returns from the last 3 years NAV data) to the banking category makes the category more risky in comparison to the other equity oriented categories. Likewise, the inhibit character of high sensitivity to the market conditions makes it a high beta one among the other categories.

6 Allocation to Sectors by the Banking Category: Top 10 Stocks held by the Banking sector category: Top performing schemes from banking category: Scheme Name Age (Yrs) Benchmark Latest Corpus (Rs Crs) Expense Ratio (%) Trailing Returns (%) Rolling Returns (%) Standard ICICI Pru Banking & Financial Services (G) 6.29 BANKEX Reliance Banking Fund - (G) CNX Bank R* Shares Banking ETF 6.45 CNX Bank /0.06 GS Bank BeES CNX Bank /0.09 Benchmark: Banking Equity Diversified Category CNX Bank Index Bankex CNX PSU Banks Nifty Month Absolute 1 Year 3 Year 5 Year 7 Year 6 Month Absolute Note: NAV values are as of Oct 30, Rolling Returns are calculated from the last 7 years NAV history. Standard Deviation and Tracking Error are calculated from last 3 years data. 1 Year 3 Year 5 Year Deviation / Tracking Error

7 ICICI Pru Banking & Financial Services (G): Performance of the schemes on various time frames (Point to point returns): Performance of the schemes during various cycles: Portfolio Sector Allocation: Market Capitalisation:

8 Reliance Banking Fund - (G): Performance of the schemes on various time frames (Point to point returns): Performance of the schemes during various cycles: Portfolio Sector Allocation: Market Capitalisation:

9 R* Shares Banking ETF: Performance of the schemes on various time frames (Point to point returns): Performance of the schemes during various cycles: Portfolio Sector Allocation: Market Capitalisation:

10 GS Bank BeES: Performance of the schemes on various time frames (Point to point returns): Performance of the schemes during various cycles: Portfolio Sector Allocation: Market Capitalisation:

11 Analyst: Dhuraivel Gunasekaran Source: NAVIndia & ACEMF Tel: (022) Fax: (022) Corporate Office HDFC securities Limited, I Think Techno Campus, Building - B, "Alpha", Office Floor 8, Near Kanjurmarg Station, Opp. Crompton Greaves, Kanjurmarg (East), Mumbai Phone: (022) Fax: (022) Website: [email protected] Disclaimer: Mutual Funds investments are subject to risk. Past performance is no guarantee for future performance This document has been prepared by HDFC Securities Limited and is meant for sole use by the recipient and not for circulation. This document is not to be reported or copied or made available to others. It should not be considered to be taken as an offer to sell or a solicitation to buy any security. The information contained herein is from sources believed reliable. We do not represent that it is accurate or complete and it should not be relied upon as such. We may have from time to time positions or options on, and buy and sell securities referred to herein. We may from time to time solicit from, or perform investment banking, or other services for, any company mentioned in this document. This report is intended for non- Institutional Clients This report has been prepared by the Retail Research team of HDFC Securities Ltd. The views, opinions, estimates, ratings, target price, entry prices and/or other parameters mentioned in this document may or may not match or may be contrary with those of the other Research teams (Institutional, PCG) of HDFC Securities Ltd.