Banking funds are booming, up 37% in net assets. Smart buy?

Bank stocks like HDFC & ICICI are investor favourites. So, how often do banking funds beat the market? Let’s find out.

Investors have poured nearly Rs 48,000 crore into mutual funds that solely invest in the banking and financial services sector —a 37 per cent year-on-year jump (May 2025)—according to a Press Trust of India report.

The sudden surge reflects growing optimism around bank stocks, which have had a strong run this financial year. On the surface, the interest seems well-placed. Indian banks are well-capitalised, credit growth is healthy and asset quality is stable. But does this justify betting big on a single sector?

At Value Research, our answer is usually no. Because there’s a better alternative.

So, let’s find out why.

The returns don’t stack up

There are currently 66 banking and financial services-focused mutual funds and ETFs. But their long-term track record leaves much to be desired:

• Over the past decade, banking sector funds underperformed flexi-cap funds 82 per cent of the time on five-year rolling returns. Simply put, let’s assume you invested in a banking fund and a flexi-cap fund at any point over the past decade and held them for five years. In a little over eight out of 10 cases, the flexi-cap fund would have done better.
• Their average five-year return was just 10.2 per cent, lower than the Nifty 50 TRI’s 13 per cent.
• What’s more, banking funds crossed the 10 per cent return mark just 53 per cent of the time. In other words, in nearly half the cases, banking funds didn’t even beat the 10 per cent mark. Now compare that to flexi-cap funds. They delivered 10 per cent and more annualised returns 72 per cent of the time.

That means flexi-cap funds gave strong returns more consistently, while banking funds were more hit-or-miss.

Let’s look at how the returns actually panned out in the last 10 years:

Lesson for investors

Unlike diversified equity funds that spread your money across industries, sectoral and thematic funds place all their chips on one part of the economy — like banking, pharma, IT or infrastructure. That makes them high-conviction bets: they work great when the sector is booming, but when the cycle turns, they fall hard and fast.

We’ve seen this before. During the 2010s, infrastructure and power sector funds were the toast of the town, until regulatory delays, stalled projects and debt-laden balance sheets dragged them down for years. Many investors who entered late were stuck with poor returns for a decade.

The same applies to banking funds. Do you remember the time when several banking funds underperformed as NPAs (toxic loans) piled up? At that time, the banking funds were an unholy mess.

The better-for-you alternative

The good news is that even if you don't own a banking fund, chances are your portfolio already has plenty of exposure. As of May 30, 2025, flexi-cap funds held 26 per cent of their portfolio in Financials—banks, insurance companies, NBFCs and fintechs. This natural allocation gives you sector exposure without the risks of betting solely on one sector. It’s like getting the upside, without being hostage to just one industry's fortunes.

Our take

We prefer diversified equity funds that are better suited to long-term wealth creation. Flexi-cap and multi-cap funds offer enough exposure to banking stocks while protecting you from the sector’s volatility.

So yes, the banks may be booming. But smart investing isn’t about chasing what’s hot—it’s about staying diversified and disciplined.

Also read: Fund Radar: Defence funds are soaring. Good time to invest?