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The Influx of Banking Funds

With 5 new banking funds coming up it seems like the sector is heating up, but that might not happen

The enthusiasm with which fund companies are launching new funds remains unabated. In February and March, there was a bit of a slowdown, but this is now long gone. At this point, there are 88 new funds for which fund companies have filed offer documents with the regulator, SEBI. Of these, even if one ignores the 44 fixed maturity plans (FMPs) because they are not of interest to retail customers, there are 44 other funds that will be offered to the public sooner or later.

One interesting fact that emerges from studying this list is that there are four banking sector funds in it. While four doesn't sound like a large number by itself, one must remember that as of now there are only operational three banking sector funds in India and a fourth one that is currently in the initial offer stage. I think that this adds up to a steep increase in the interest that fund companies are showing in running banking funds. Three banking funds in all the years that the industry has existed and now five more in one go!

Many of us find this surprising considering the overall health of the financial services sector. In recent months, the sector has been in the news for all the wrong reasons. First it was the global credit crisis that began with US subprime loans and spread rapidly. Then there were its effects on Indian banks and the derivatives they had allegedly mis-sold to their corporate clients. Banks bore a major brunt of these losses with the ICICI Bank leading the way. Now, there are fresh worries about the quality of the credit that banks have issued in the massive expansion of business that has taken place in recent years. Just a couple of days ago, CRISIL, a credit-rating agency, downgraded commercial vehicle loan-based securities of ICICI Bank by four notches.

The banking indices of the stock markets too reflect these worries. While in 2007 these indices delivered about 10 per cent more return than the Nifty and the Sensex, these good times haven't lasted. While the last three months have seen the Nifty and the Sensex only slightly in the red, the Bank Nifty index has been in a freefall, giving a negative return of 17 per cent.

These contrasts between the generally poor outlook of the banking and financial services sector one the one hand and the enthusiasm of the fund companies puzzles me. The obvious explanation is that the existing banking funds have managed to collect a lot of investors' funds over the last year and now more fund companies have decided to get their hands on to this bonanza. During the financial year 2007-08, the unit capital (the actual investor's funds) of the three banking funds shot up by almost three times. Obviously, other fund companies find the temptation irresistible.

I find this sudden enthusiasm for the sector alarming. Quite frankly, this reminds me of the dying days of the technology boom. Till a certain stage, there were just two or three tech funds. Then suddenly, there were ten of them. And then just as suddenly the crash began. Did you know that some of the pain of those days is still around? Kotak's Tech Fund, which was launched at the peak of the tech boom back in 2000, still has an NAV of just Rs 8. Investors who put in money during this fund's NFO haven't been able to recover their initial losses even after eight long years!

Investing in the heady days when a sector looks the hottest may feel like the right thing to do, especially when one reads fund companies' advertising. However, we must remember that by the time a sector starts looking so hot that everyone is launching funds for it, its days of making money may already be over.