Financial sector can give high long-term returns

Published: July 23, 2018 1:32:11 AM

Most investors seek long period growth at justifiable valuations as the best combination. The financial sector offers the same in a better manner as compared to most other sectors for reasons listed below.

Well-run banks and NBFCs, which are growing well, have been able to expand branch network and are able to use technology to gain market access.

Most investors seek long period growth at justifiable valuations as the best combination. The financial sector offers the same in a better manner as compared to most other sectors for reasons listed below. Well-run banks and NBFCs, which are growing well, have been able to expand branch network and are able to use technology to gain market access. Hence, cost to income ratio for most entities growing well has been dropping sharply overtime.

Stable margins
A reduction in cost to income in a scenario of stable margin implies large value creation for investors. Margins are expected to remain stable because this phenomenon is seen only in well-managed growing entities. PSU banks that still account for bulk of lending in the country, have not shown the same decline. The spread in the business should hence be preserved and entities which are witnessing cost to income ratio decline are in a good position to keep the benefit.

Technology and reforms have made the addressable space larger. Relatively unbanked areas like micro-finance have seen good profitability and as the lending size in this area has increased, the profitability has also increased. Technology and reforms like Aadhaar and credit scores make this space very scalable. Aadhaar implementation has reduced customer acquisition costs and hence banks are not willing to on-board customers hitherto unserved. Increasingly, banks are acquiring new customers using Aadhaar-based verification. Some micro-finance entities have converted themselves into small banks and some are merging with banks.

Financial savings
Indians have traditionally been big savers with assets of choice being real estate and gold. After demonetisation, there is a clear trend towards financialisation of savings. Formalisation of economy (led by GST) has ensured that the parallel black economy shrinks and people move to white economy, thus bringing them into the banking system. Bank deposits increased sharply (though they have normalised since) and flows into both debt and equity mutual funds have sharply risen. SIPs into equity funds which used to be `3,000 crore a month, two years ago are crossing Rs 7,000 crore a month. Wealth management outfits and AMCs have seen a strong growth in their businesses and expect the growth to continue. Insurance companies are also seeing renewed strength in flows. These are high quality, underpenetrated spaces and growth could continue for a long period of time.

Structure of the market
Financial sector is a space where public sector entities continue to have a dominant presence. However, the market share of PSUs which used to be over 70% till FY15, has dropped sharply. The transfer of market share to private sector is resulting in overall value creation. Bank index has managed to deliver strong alpha over the Nifty over the past three to four years even while there have been market share shifts.

Well-run financials which include lending business and fee based businesses like MFs, private banking, exchanges, rating agencies, etc offer some of the best opportunities to compound monies over long term. Most financial sector stocks are liquid and can absorb large investments, making this space very relevant both to institutional and retail.

Prateek Agrawal
The writer is business head & CIO, 
ASK Investment Managers

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