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Turnaround in sight at private banks, now is the time to bet

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Investors looking for a thematic bet in their equity portfolios with a margin of safety can consider an allocation to the Nifty Private Bank ETF. A sharp improvement in return ratios, expected economic growth, reasonable valuations, and recent underperformance compared to the PSU banks make this a good bet for investors with a high appetite for risk, wealth managers said.

The Nifty Private Bank Index has underperformed the Nifty 50 and PSU Bank indices over the last one year. It returned 11.08% compared to the Nifty 50’s 12.7% and PSU Bank ETF return of 64.21%. Over a three-year period, the Private Bank ETF returned 26.11%, higher than the Nifty’s 22.20%, but lower than the PSU Bank ETF’s 59.05%.

Due to this underperformance, the valuations of private sector banks have come off. Data from DSP Mutual Fund show private banks trade at a price-to-book (P/B) of 2.8 compared to its historical average of 3.2 over the last 17 years. On the profitability front, they have seen a sharp rise in return ratios in the last four years. The return on equity (ROE) and return on assets (ROA), key metrics used by analysts to track returns for private sector banks, stood at 9.5% and 1% in FY19 and increased to 15.4% and 1.8% in FY23.

Turnaround in Sight at Private Banks, Now is the Time to Bet

“Private banks are trading below their historic averages and are significantly lower than the broader Nifty 50. Historically, Nifty Private Bank has outperformed Nifty 50 on a three-year rolling return basis,” said Anil Ghelani, head of passive investments at DSP Mutual Fund. Ghelani believes there is a strong case for investing in the private bank ETF with a three-year time frame.

The Nifty Private Bank ETF has a concentrated portfolio of 10 banks with HDFC Bank, ICICI Bank, Axis Bank, Indusind Bank and Kotak Bank constituting about 80% of the portfolio. The other five stocks – Federal Bank, IDFC First Bank, Bandhan Bank, RBL Bank and City Union Bank form the remaining 20%.

“Over the past year or so private banks have underperformed compared to PSU banks as asset quality improvements have been largely seen in PSU banks, which had made heavy provisioning against NPAs in the past,” said Deepak Jasani, head of retail research at HDFC Securities. Jasani believes that compared to historical valuations, private banks are trading at average valuation and looking at the growth potential over the coming years, there is significant headroom to grow.

Analysts said due to strong management and aggressive strategies, private sector banks will continue to take market share from their public sector counterparts. They also believe private banks have strong subsidiaries in high-growth businesses like asset management, wealth management, and life and health insurance, where value will be unlocked in the coming years.

“Most of these banks have subsidiaries in financial services, a space which is expected to grow meaningfully, thereby adding to overall valuation comfort,” said Chintan Haria, head-investment strategy at ICICI Prudential Mutual Fund. Haria believes the private bank ETF is one of the ways to play the India growth story over the next three to five years as investors get the opportunity to gain not only from banks but also from its subsidiaries in growth areas like asset management, insurance and broking companies.

Jasani said investors worried about volatility, could stagger using SIPs, with a 2-3 years’ time frame.

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