Weekly Musings – NFO Pick (Bandhan Bank Nifty Index Fund)

13 Aug 2024 , 09:16 AM

WHY A BANK INDEX FUND NOW?

One of the big questions we need to address when we talk about the Bandhan Bank Nifty Index Fund is; why a bank index fund now. The quick response is that after a long time, private banks are available at very reasonable valuations. One can argue that their NIMs are likely to narrow and ALM mismatch is a risk in the balance sheet. However, that does not change the macro story. And the macro story is that; Indian economy is likely to grow exponentially in the coming years. Banks are best proxies for macroeconomic growth.

Consider these numbers! The nominal GDP is expected to grow from the current $3.7 Trillion to $4.5 Trillion by 2025 and to $5.5 Trillion by 2030. That is a huge leap of faith for the economy. What it also means is that; per capita GDP will go up from $2,449 to $2,830 in the next couple of years, unleashing massive consumption and spending power in the economy. That would also mean a rapid growth in household savings and in credit needs, both of which are likely to benefit the banks. The idea of a passive fund is to play the high potential banking story, without taking individual stock selection risk.

HOW BANKING IN INDIA HAS CHANGED IN THE LAST DECADE?

In the last 10 years, the Indian banking sector has transitioned from being a sector struggling with an overload of NPAs to a highly profitable and thriving sector driving the Indian economy. Here are some major triggers behind this change.

• Banks have got a mix of recapitalization from the government and greater freedom, leading to gradual reduction in the NPA levels. This has not only improved asset quality but most of the potential NPAs are also provided for adequately.
• There is a lot more focus on profitable business and profitable market segments. This has resulted in a steady improvement in the return on equity (ROE) of the banks and the return on assets (ROA) ratios of the banks in general.
• Measures like the Prompt Correction Action (PCA) initiated by the government helped maintain a tight leash on banks with high NPAs. Coupled with capitalization and mergers, the struggling PSUs have been rationalized and allowed to grow.
• The banks, as a result, have seen lower gross NPAs, lower net NPAs, higher credit growth and higher levels of profitability and profitability ratios. Most banks have seen a sharp improvement in the net interest margins (NIMs), which is the real test.

Banks have not just improved their asset quality, but also improved their capitalization buffers in the last few years. In the process, retail credit has gained share as a share of total credit, but that is par for the course.

HOW GOOD IS A BANK INDEX FUND AT THIS JUNCTURE?

There are several arguments in favour of a bank index fund at this juncture and there is enough statistical evidence to back it up. That is what makes a strong case for the Bandhan Nifty Bank Index Fund.

• Across time frames, the average rolling returns on the Bank Nifty has been higher than the Nifty. The positive spread for the Bank Nifty ranges from 310 bps over a one-year period to 270 bps over a 5 year period.
• The trailing of P/E ratio of the Bank Nifty had touched a peak of 65X in 2018 and 2019. Since then, the profits of banks have gone up phenomenally, but valuations have not really gone up. Hence, the P/E ratio today stands at 16.07X, compared to the 10-year average of nearly 27.3X, and marking the lowest level in the last 10 years.
• If you compare the Bank Nifty with other key sectoral indices, only auto is at a deeper discount to the 10-year average P/E, as compared to Bank Nifty. The Bank Nifty is at a 41.5% discount to the 10-year average P/E while sectors like IT and FMCG are at a premium to their average 10-year P/E ratios.

However, before investing in the Bandhan Bank Nifty Index Fund, it is essential to understand what kind of investors this fund is best suited for. The Bandhan Bank Nifty Index Fund is best suited to seasoned investors looking for a sector-specific exposure to banks, on a passive basis. Such investors must be prepared for high levels of volatility and also potential underperformance by the fund.

PERFORMANCE OF BANK ORIENTED FUNDS IN INDIA

Here is a quick look at how the bank oriented funds in India have performed over 1-year and since inception. We have taken active banking funds and passive bank index funds to give a comprehensive picture. There are 32 such active and passive bank oriented funds in India, of which we have ranked the top-25 in the table below. While the returns of regular plans have been considered for passive funds, the direct plans have been considered for the active funds to neutralize the impact of TER. Here are the top-25 bank-oriented funds in India on 1 year returns.

Scheme Name	NAV (in ₹)	Return (%) 1-Year	Return (%) Since Launch	Daily AUM (₹ in Crore)
Kotak Nifty PSU Bank ETF	698.73	54.64	5.96	1,363.75
Nippon India ETF Nifty PSU Bank BEES	77.95	54.57	6.77	2,489.84
SBI Banking & Financial Services Fund	40.62	30.39	15.98	5,889.46
Baroda BNP Paribas Banking and FS Fund	45.89	24.08	12.10	163.08
Nippon India Banking & FS Fund	606.34	23.66	14.73	5,944.53
UTI Banking and Financial Services Fund	189.65	23.36	12.18	1,123.53
Kotak Banking & Financial Services Fund	14.18	22.58	27.22	911.14
ICICI Prudential Banking and Financial Services Fund	133.20	20.63	16.17	7,677.04
Mirae Asset Banking and Financial Services Fund	19.24	20.32	19.57	1,778.05
HDFC Banking & Financial Services Fund	15.90	20.19	16.06	3,476.34
Tata Banking and Financial Services Fund	43.24	18.77	18.51	2,203.02
Aditya Birla Sun Life Banking & FS Fund	60.77	17.50	18.44	3,164.79
ITI Banking and Financial Services Fund	14.13	15.58	13.78	263.58
Mirae Asset Nifty Bank ETF	508.03	13.13	9.86	145.71
UTI Nifty Bank ETF	51.60	13.12	22.09	3,418.07
ICICI Prudential Nifty Bank ETF	51.24	13.09	10.59	2,909.27
Aditya Birla Sun Life Nifty Bank ETF	51.17	13.09	12.50	2,647.29
DSP Nifty Bank ETF	51.10	13.09	11.54	520.55
Nippon India ETF Nifty Bank  BEES	517.28	13.05	16.62	6,735.94
Kotak Nifty Bank ETF	518.14	13.05	11.25	5,733.36
SBI Nifty Bank ETF	512.93	13.05	11.77	4,487.64
HDFC NIFTY Bank ETF	51.39	13.04	23.39	2,417.32
Axis NIFTY Bank ETF	515.01	13.02	18.24	262.41
LIC MF Banking & Financial Services Fund	21.59	12.37	8.55	286.99
ICICI Prudential Nifty Bank Index Fund	14.17	12.31	15.36	456.65

Data Source: AMFI

The table above provides the performance of bank oriented funds in India, over 1-year and since inception. There are a total of 32 bank oriented funds (active and passive) in India, but we have only ranked the top 25 in the table above. These 32 bank oriented funds manage  a corpus of ₹70,696 Crore between them. Here are some key takeaways.

• Let us first look at the returns on bank oriented funds over a 1-year period. On a 1-year returns basis, these bank oriented funds generated maximum returns of 55.02% and minimum returns of 8.81%, which is a fairly wide dispersion in terms of returns. The average returns over a 1 year period was 18.94%, which is impressive, although the high dispersion is a concern.
• Let us now turn to the returns on bank oriented funds since inception. If measured since inception, these bank oriented funds generated maximum returns of 60.09% and minimum returns of 5.96%, once again a classic case of high dispersion. The average returns since inception was 15.14%, which is fairly impressive, although the dispersion is quite high, making fund selection quite a tough task.
• Let us finally look at the break-up of the winners in the table above and whether they tilt towards active banking funds or passive banking funds. If you look at the top-10 by 1-year returns, then the top two are passive funds while the other 8 are active funds. However, the top two are PSU bank ETFs, which did extremely well in the last one year. In other words, active funds have done well on a diversified basis. What about returns since inception? Here the picture changes slightly. While the top two are still the PSU bank ETFs, there are a total of 6 passive funds in the top ten. That could imply that over a longer period of time, there is a very high probability that you may be better off participating in the banking sector through passive funds. So, that does make a strong case for the Bandhan Nifty Bank Index Fund.

In the last few months, the valuations of private sector banks have become a lot more reasonable, although PSU banks may be a little stretched. However, the idea here is that .

GLANCE AT THE BANDHAN BANK NIFTY INDEX FUND NFO

Here are some details of the Bandhan Bank Nifty Index Fund NFO you must know to decide on investing in the fund.

• The NFO of Bandhan Bank Nifty Index Fund opened for subscription on August 08, 2024 and will close on August 22, 2024. Being an open-ended index fund, with focus on banks forming part of the Bank Nifty, it will reopen for sale and repurchase anywhere between 3 days and 15 days of NFO closure. The Bandhan Bank Nifty Index Fund is best suited to investors looking for a passive approach to participating in the banking sector in India. The passive approaches does away with the risk of stock selection.
• The core focus of the Bandhan Bank Nifty Index Fund is to replicate the Bank Nifty index by creating an underlying portfolio that exactly mirrors the Bank Nifty index in terms of index composition and weightages. The focus will be on long-term capital appreciation, through a passive approach to investing in banks; so, a holding period of 5-7 years at the bare minimum would be required to realize the full benefits.
• On the Standard SEBI Risk-O-Meter, the Bandhan Bank Nifty Index Fund will be ranked as a Very High Risk Fund. The high risk is an outcome of the predominant exposure to equities (80% to 100%) that the Bandhan Bank Nifty Index Fund will have. In addition, there is also the thematic risk of being entirely focused only on the banking sector. Being a passive fund, it does away with the risk of fund manager stock selection.
• The Bandhan Bank Nifty Index Fund is about generating capital appreciation from a portfolio of banking stocks mirroring the Bank Nifty index. The focus will not be on stock picking but on minimizing the tracking error. The Bandhan Bank Nifty Index Fund will focus on creating a portfolio that merely replicates the Bank Nifty Index.
• Investors can invest in the NFO of Bandhan Bank Nifty Index Fund in minimum size of ₹1,000 lumpsum and in multiples of ₹1 thereof. This also applies to additional purchases and switch-ins. Minimum monthly SIP (systematic investment plans) will have to be at ₹100 and in multiples of ₹1 thereof for a minimum of 6 months. The fund also supports the systematic investment plans (SIPs) and systematic transfer plans (STPs) programs.
• While there is no entry load, there will be an exit load of 0.25% if the fund is redeemed within 15 days from the date of allotment of units. That is because early exits may be detrimental to continuing unit holders. This also applies to switch outs. Any redemption or switch out after 15 days will not attract any exit load. However, investors are advised to hold the fund for 5-7 years to get full benefits of the Bandhan Bank Nifty Index Fund.
• The Bandhan Bank Nifty Index Fund does not give any guarantee on returns and the performance of the fund is subject to the vagaries of the markets in general and the performance of the banking sector in particular. The Bandhan Bank Nifty Index Fund will be benchmarked to the Nifty Bank Index, which it will seek to replicate and minimize the tracking error. Being a passive fund, the question of alpha does not arise.
• The Bandhan Bank Nifty Index Fund will be managed by Nemish Sheth and his team. The intent of the fund management team will be replicate the Nifty Bank Index and keep the tracking error at the bare minimum. Computer Age Management Services (CAMS) will be the registrars to the fund.

The Bandhan Bank Nifty Index Fund NFO offers an opportunity for investors to participate in the upside opportunity in the Indian banking sector through a passive index based approach. This passive approach largely eliminates the fund manager bias in investing.

TAX TREATMENT FOR BANDHAN BANK NIFTY INDEX FUND

Post the Union Budget announced on July 23, 2024; there are some key changes to the way the returns earned on the Bandhan Bank Nifty Index Fund will be taxed. Being an equity index fund, it will be taxed at par with equities under the Income Tax Act.

• The holding period criteria for short term and long term capital gains is 1 year. If the Bandhan Bank Nifty Index Fund is held for 1 year or more, it will qualify as long term capital gains. Capital losses can be written off against gains and also carried forward.
• The dividends declared by the fund, if any, will be taxed at peak rate of tax applicable. In addition, if the dividends exceed ₹5,000 in a year, they will be subject to tax deduction at source (TDS), under the extant income tax rules.
• STCG tax treatment has undergone a change in the July 23, 2024 Union Budget. The short term capital gains on units sold before 1 year will be taxed at 20% on gains plus cess at 4%, making effective STCG rate 20.80%. It was raised from the old rate of 15%.
• The LTCG will be taxed at a flat rate of 12.5% (up from 10%). However, threshold exemption limit has also been increased from ₹1 Lakh to ₹1.25 Lakhs. Even in this case, the tax impact will be 13% after including the 4% cess.

Investors need to factor in the changed taxation rules before investing in the Bandhan Bank Nifty index Fund and understand the implications on post-tax returns.