Banking sector funds are the latest fad for mutual fund houses

There’s a new fad in the mutual fund world these days. After thematic funds based on natural resources hit it big earlier in the year, mutual fund houses are now betting their money — or rather investors’ money — on banking sector funds.

Consider this: Reliance Mutual Fund has just launched the Reliance Banking Exchange-Traded Fund (ETF). Then, Lotus India Asset Management Company has launched its Lotus India Banking Fund, which is open for subscription till June 17. And Sundaram BNP Paribas Mutual Fund too has added a Financial Services Opportunities Fund under its Select Thematic Funds umbrella. More such funds are also on the cards reportedly.

Reliance Mutual Fund’s Banking ETF will be benchmarked to the CNX Bank Index, the banking ind-ex of the National Stock Exchange. It will thus track that index and aim to mirror its returns. The Lotus India Banking Fund too will invest a minimum of 65 per cent of its corpus in stocks that feature on the CNX Bank Index list.

Why are all these funds looking at banking sector funds? It’s true that the banking sector was a top performer in 2007 with the CNX Bank Index giving a huge 63 per cent returns that year. For the point-to-point 12-month period from May 24, 2007 to May 23, 2008, however, the returns had moderated to around 13 per cent. While in the year to date from January 1, 2008 to May 23, 2008, the returns were a negative 29 per cent.

“I’m a bit concerned by these banking funds because sector funds are really a short-term story and they also offer limited scope to the fund manager. No prudent advisor should advise anyone to invest in sector funds,” says Atul Karve, partner, Blue-Chip Investments.

The mutual funds are pushing the banking story on the basis of India’s economic growth and they believe that there is under-penetration of banking services in the country. Yet Karve points out that the banking sector is still facing problems. For one, there has been the sub-prime mortgages crisis, and the resulting derivatives losses especially at banks like ICICI Bank.

“There are problems with the quality of lending here as well,” says Karve. Besides, the tightening monetary policy, slower credit growth and rising cost of funds (given high deposit rates) are also likely to affect the banks’ margins.

How have the existing banking sector funds fared in all this? There are three such funds currently: UTI Banking Sector Fund, Reliance Banking Fund and JM Financial Services Sector Fund. While the top performer, Reliance Banking, gave 25.59 per cent returns for the year ended May 23, 2008 against the category average return of 18.42 per cent, over the three months ended May 23, its returns were a negative 11.72 per cent. The category gave a negative 15.86 per cent in this period. (Source: valueresearchonline.com.)

But Karve says, “You need to take a long-term call on the growth outlook for the future and not on past performance.”