As you might be aware, sharp swings in the sentiment as well as in the fundamentals of a particular sector can result in huge loses. PersonalFN has been repeatedly cautioning investors about the risky nature of sectorial and thematic funds. But, you would be surprised to know, sometimes, lull in a particular sector can show negative impact on returns generated even by a diversified mutual fund.

This may happen when many of them (diversified mutual funds) are betting big on a particular sector and that sector fails to perform. Take an example of banking sector.
 

S&P BSE 500 vs S&P BSE Bankex

Data as on January 17, 2014
(Source: ACE MF, PersonalFN Research)
Broader equity markets have failed to reward investors over last 1 year. In fact, S&P BSE 500 has generated negative returns of 0.4% on 1-Year time frame. Primary reason behind such underperformance has been the dismal performance of Banking and financial stocks. Financial sector has a weightage of about 23% in S&P BSE 500 as per the last disclosed data. S&P BSE Bankex, which captures the movement only of financial stocks, has registered deeper losses. It fell by about 14% over last 1 year. As far as performance of S&P BSE 500 is concerned, relative outperformance of Information and Technology (I.T.) and Fast Moving Consumer Goods (FMCG) arrested the down fall. I.T. and FMCG together, carry around 27% weight in S&P BSE 500.

Impact on Mutual Funds...
On an Average, banking sector funds have generated -16.0% returns over the past 1 year. In other words, collectively, their performance has been worse than that of S&P BSE Bankex. But diversified mutual funds too suffered due to their relatively high exposure to banking stocks. Top-20 funds, as per Asset under Management (AUM), held about 20% of their portfolios in banking and financial stocks. Top-20 funds represent approximately 60% of total AUM of diversified equity funds.

What's wrong with the sector?
Banks suffered on two fronts in 2013. First, quality of assets deteriorated due to various reasons. Lower growth in factory output affected the debt-servicing ability of many players. Banks received a number of high-profile cases applying for debt restructuring. Under Corporate Debt Restructuring (CDR) window about 77 borrowers requested a debt recast worth approximately Rs 74,000 crore in 2013 which is considered high by any standard. Although tough economic environment was the primary cause for deterioration of quality of assets there was a worry about credit assessment as well. RBI also expressed its concern about lapses in the credit and risk management that might have prompted the difficulty in maintaining the quality of lending.

Secondly, lower interest income, higher provisioning due to rising distressed loans and relatively high cost of borrowing negatively affected the profitability of banks. RBI tightened the reins on liquidity in the banking system during 2013. This affected the cost of funds banks for banks as interest rates on short term loans (to banks) went up substantially. While cost of borrowing went up, banks, especially the public sector banks were advised not to immediately pass on the rise in the cost to borrowers, affecting their business margins. Due to bad performance of Indian rupee and higher domestic inflation, scope for RBI to support growth by lowering policy rates was capped.

What to expect?
Baking sector may continue to rumble under pressure, going forward. Asset would remain to be a cause of concern for banks until economic growth picks up and debt servicing ability of companies improves. Moreover, higher provisioning may continue to eat into profits of banks.

Besides, keeping aside buffer against distressed assets, provisioning of banks may further go up due to some changes brought and likely to be brought by RBI. Being concerned about the un-hedged positions of a number of corporate on foreign exchange borrowing, RBI recently tightened the provisioning norms for banks having exposure to such companies. Since RBI cannot govern companies, it is trying to mitigate the risk by putting impositions on banks. Furthermore, if the recommendations of the committee headed by Nachiket Mor (Central Board Member of RBI) are accepted, priority sector lending requirement may go up from 40% to 50% for all public sector banks, private banks as well as the foreign banks having more than 20 branches in India. Priority sector lending may have adverse impact on profitability.

PersonalFN View:
PersonalFN is of the view that, although diversified mutual funds are safer than sectorial and thematic funds, they must be selected wisely. Concentrating only on funds which have generated the highest returns in the past may prove to be dangerous for you. It is possible that, the top performer might have also been the highest risk-taker. PersonalFN believes apart from historic returns, one should also give attention to other factors such as sector concentration, stock concentration and schemes to fund manager ratio to name a few. Mutual funds excessively depending on fund managers rather than their systems and investment processes, are likely to generate inconsistent returns. You may not bother about short term underperformance of your fund but may consider replacing the existing fund with a close substitute when risk-return proposition becomes unfavourable. Therefore, for the time being without bothering about the exposure of your fund to the banking sector, you may continue to hold it till it satisfies the aforementioned criteria.

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ednl3dqf@yahoo.com Mar 17, 2014 Good Morning, my name is Karen Hall I am with the Limestone Free Will Baptist Church in Limestone, Tn. I would like to put a order in for the 2012 PreThanksgiving Week of Prayer bookmarks of a total of ( 150 ). I would also like to thank you all for what you do each day and I actperiape you all very much.Thank You,Karen Hall LFWBC

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