Banks Are Structurally Well-Placed, Says Bandhan AMC's Sumit Agrawal

Sumit Agrawal: See, one thing is quite clear that while the larger banking P/Es have clearly underperformed the broader market in the last three years, and within the overall ambit of financial services, there have been pockets of various other sub-segments, or maybe even in the banking side, if we see especially within the PSU pack and some of the other names, those names have actually outperformed.

This kind of corroborates with a global rally probably in the last two three years in the value cyclicals and that has led to the kind of performance that we have not seen for a long time. That is where we think that in the medium to long term the current valuations for overall financial services, if you pick and choose wisely at quite attractive levels and if someone has an eye for bottom-up stock-picking, can very well construct a portfolio which is very different from the index or the benchmarks or the typical heavyweight of positioning that we see across diversified funds.

At least that is something which we have endeavoured to do in this fund and we are constructing a portfolio which has been very different as compared to all the peers as well as the index. And in the last few months since launch, we have seen some fruits of the stock picking.

Sumit Agrawal: Fair observation. But the thing is, if you look at the construct of the index today, let's say, the most prevalent index in the market is Bank Nifty or a Nifty Financial Services Index.

My belief is probably they do not represent a lot of opportunities that the sector actually presents. For example, a Bank Nifty has just about 12 stocks. Similarly, Nifty Financial Services has about 20 stocks.

So if you look at the construct of those stocks, maybe a Nifty Financial Services does have a couple of insurance names and maybe one asset management company, but then there is a whole host of sub-segments to play which are not represented in the index at all.

Therefore, if you invest a lot of money, hugging the benchmark and be very lopsided in the top heavyweights, which are generally banks, it would be difficult to create alpha. First of all, this space itself is not performing. At the same time, you have active money which you can deploy, but if you're hugging an index, it's very difficult to perform differently from the index.

On the whole, it also gives us flexibility to deploy the money in different baskets. For example, the entire private sector retail space—since last one-and-a-half years or so, after the rise in rates—is slightly struggling because there's clearly pressure on liquidity and deposit growth is struggling and at the same time, there is nudge from the regulators for banks and institutions to actually reduce their LDR (loan-to-deposit) ratios.

So clearly, between credit growth, asset quality and margins, probably we are scoring fairly well on credit growth and asset quality but margins are something which have been a weak factor at work. Therefore, we have taken a conscious call of being underweight in this sector. At the same time, whatever allocation we save from under-allocating is deployed into other performing sectors and various other sub-segments, which I can discuss later on.

Sumit Agrawal: Very fair observation. In fact, structurally, if you ask me, for the next 3–5 years, I think banking as a pack is placed very well, because clearly, valuations are no longer premium, of what they used to be.

In fact, the leading banks are trading somewhere close to two, two-and-a-half times price-to-book versus, you know, three-and-a-half to four times price-to-book. At the same time, fundamentally, we did not see any pressure on asset quality.

In fact, it has been one of the healthiest times for the Indian banks currently in terms of asset quality. Credit growth is actually picking up. You'll see a lot of pickup in industrials and capex and after a long time, you're seeing even a commodity revival, which in a way is good from a credit growth perspective.

The only thing, which is weak as I said earlier, is a little bit on the liquidity. But going forward, let's say, if you have a view over the next one year, overall rates should actually be lower than what we are today. That would be NIM positive, in my view.

So again, all these three engines of growth will be at play for the sector and at the same time, the private sector banks probably are at much reasonable valuations. So all these four factors coming together, I think, bodes quite well for this pack as a whole.

See, I would like to compare this with a situation of let's say, what PSU banks were about two to three years ago and asset quality problems were behind. There was adequate capital available. And clearly, credit growth, they have been growing in line with the system. But valuations are very supportive and that's why we saw PSU banks rallying from halftime price to book to maybe close to one time price to book or slightly over today. That pack has been a clear outperformer in the last 2–3 years.

So I see a similar situation in the private sector banks today. Obviously, as investors, psychologically it's very difficult to buy something where you think in the near term there is a problem because of the margins pressure or liquidity pressure. But I think that is when the maximum amount of money is made, if you have patience for holding on for a bit longer.

Sumit Agrawal: That is probably my view. The top private sector banks, they're very large in terms of their market caps and most of them fall in the large-cap bucket.

But then, we have a lot of PSU banks, who also feature in the mid and small-cap segment. So if you have an industry wide or a sector-wide tailwind, or in the mid small, that can also support PSU banks.

My personal view on PSU banks is not very negative, but clearly from a valuation point of view—we're looking at the sector in the past 20 years— I think, whenever valuations are supportive, that is where higher allocation should be and whenever valuation starts becoming expensive or full despite a good visibility on growth, the allocation should come down.

So when you're already sitting on a lot of good performance, and assuming you're allocated well to them, I think, it would make sense to move some money or rotate some money within the same sector itself for the next 3–5 years.

Sumit Agrawal: Very interesting. They are a good play in my view, because historically, typically, the valuations for mid-cap or small-cap private sector banks get tagged or benchmarked to their large-cap peers.

And in this case, currently, large caps themseleves are underperforming. Therefore, the valuations of the mid and small-cap private sector banks are accordingly at much lower than the large caps themselves.

Fundamentally, the industry tailwinds are good for them as well. These are generally run by good credible managements and a few accidents that we have seen in the past, obviously they can be pockets where some small bit of tidbits can go wrong, but on the whole I do not see any great mistakes or any great areas of concern for even the small and the mid private sector banks.

So you're right in a way. Outlook remains good even for the mid-cap and small-cap private sector banks.

Sumit Agrawal: I think it's more of a non-linear growth opportunity in the segment and you and I are witnessing this happening in front of our eyes.

The sheer number of new investors entering into the market, the number of demat accounts, the number of SIPs in the market, or let's say transactions happening in the cash market or derivatives market, exchanges coming up with differential expiries or weekly options and you know, experimentation with so many things.

And the same goes with, you know, adoption of technology by traditional brokers, where in we innovated from ringside trading to probably tech-based trading today. The speed at which KYC happens or an account is opened and the ease of doing business.

I think all these innovations together are impacting the capital markets in a very, very positive way and I think these trends are multi-year trends rather than a yearly or a six-monthly trend.

That is where I think from the inception of the fund, we have been one of the most heavily invested fund in the capital market segment and our exposure has been very diversified.

So right from full-fledged brokerage houses to fund manufacturers to financial product distributors, to exchanges, to asset management companies themselves and some of the fintechs as well. So essentially I would say this segment is positive from the medium to long term and I would continue to look for opportunities, maybe you can find a number of new listings in the space. So you need to have a slightly open mindset to capture the financial sector spectrum.

I would like to bring to your notice, one more thing. If you look at the current AUM of all the 20 financial services funds in the country today, it is somewhere between Rs 30,000–35,000 crore.

Out of 20 funds, five funds have been launched in the last one year. Even if you analyse some of the portfolios of these funds or maybe some of the diversified funds which have 30-35% in financials, do you really think the kind of opportunity that we are talking about, a Rs 30,000–35,000 crore AUM is good enough to remain invested in this opportunity? Definitely not.

So, large amounts of money can move in all these sub-segments in the next 3–5 years. Therefore, I think one needs to have a different mindset to take advantage of this theme.

Sumit Agrawal: See, I think, I would say I'm equally positive about all these 3–4 segments that we talked about because at the macro level, if you look at the penetration level of mutual fund assets to GDP, or let's say number of household investments in the market, or let's say, the sheer spending power that people have, in all the comparisons, India as a demography gives you a thought that probably most of the things will stay here for a long term.

And if you look at some of the global markets or you know, matrices like MF AUM to GDP or you know, stock market capitalisation to GDP, those numbers are mind boggling. So essentially, the entire ecosystem will benefit. Obviously, a few players will do better or a few might do worse depending on their actions and the way they do their business, but essentially the tailwinds will be for the entire segment.

Sumit Agrawal: Without going into specific names, the theme of power finance is basically, if you remember 10–15 years ago these stocks used to be the darling of the stock markets, giving you very good NIMs and ROAs. At the time, the entire power and industrial story in India was doing quite well.

However, fortune changed in the last, I would say, 10 years or so wherein you know, merchant power fell and associated problems were there and the companies were stuck with bad loans.

What it led to, was a very attractive valuation for most of these companies and essentially, the problems of asset quality were quite behind and I would say it was more of an investor apathy to not experiment, because you know, they had a bad experience.

So essentially, as I said, our style of managing the fund despite being a thematic fund, we are very active in managing the portfolio. It is not like a buy and hold portfolio. So, the weightages currently are a result of stock price appreciation as well.

So, obviously at certain valuations it becomes more attractive and at certain valuation, you will look for an opportunity to book profits as well. But structurally, I think, this theme can still continue to do well.

Obviously, there's a lot of positive stories around it in terms of government narratives and the kind of whenever there's a new government, you know, a lot of things need to be done on these sectors.

So essentially, maybe some tinkering on the weights will be there or would have already happened. But from a longer term perspective, this is a space to be in because this was ignored for a very long time from investor's mindset.

Sumit Agrawal: NBFCs, if you see the history of India, they are supposed to be the last mile lenders. They normally reach where probably banks don't because banks are very, very well-regulated. They might not take that extra risk and therefore historically, I've seen maybe 20 or 30 NBFCs for one bank, that has been the ratio.

What is good is that today it's quite well-governed, well-enabled by technology and most of them are actually serving the needs, which banks are unable to serve in a very efficient way. So on the whole, structurally, it is a very positive thing to be in.

Within that, there are various segments. For example, there are a few NBFCs that work very well in the consumer finance space. Some might be in secured, some might be in unsecured. There might be a few NBFCs, which have worked very well in terms of gold financing.

Also they are all in this niche and there might be some NBFCs who do a mix of everything. So essentially, as you say, in the entire ecosystem, not all things go down and not all things go up.

So if a company is wise enough to pick and choose the area where it wants to operate, control the risk and push back when things go slightly bad, I think those are the kinds of managements that we would want to back.

Therefore, we have had exposure or in fact, we have exposure to almost all the segments like leading companies in vehicle finance, gold finance or consumer finance companies, some of the card companies also. Maybe some of them are doing microfinance as well.

So the idea is for a set of say 7–8 companies which are NBFCs which are operating that sub-segment, try to back one or two that you believe would do a good job and create a diversified basket so that you know risk also gets controlled and at the same time you capture the opportunity which the market is presenting.

Sumit Agrawal: See, that's a very tough question, but I'll give you an easy answer. Try to invest more where there is more fear and more disappointment in the mind and that is where you will start making money more than the market.

So the spaces, which have underperformed probably, allocate more subject to the fundamentals and do not ride too much on momentum because that is the favour of the market today and that is what over a long term will help you make good returns and grow your portfolios well.