Financial Services Sector - It’s not just Banks

Financial Services Financial Services is one of the most important sectors of an economy. Financial Services sector comprises of both Banks and Non-Banking Lending Institutions; Insurance and Asset Management Companies are also part of Financial Services Sector. A strong and well regulated Financial Services Sector can be critical for the growth of an economy.

Financial Services in India

The Indian banking system consists of 12 Public Sector Banks, 22 Private Sector Banks, 46 Foreign Banks, 56 Regional Rural Banks, 1485 Urban Cooperative Banks and 96,000 Rural Cooperative Banks in addition to co-operative credit institutions (source: RBI, data as on: 31st March 2021). Most Investors associate Financial Services Sector with Banks. However, the ambit of Financial Services Sector is broader. Apart from Banks, we have Non-Banking Lending Institutions like Term Lending, Housing Finance, Commercial Vehicle Finance, Leasing and Hire Purchase Companies, etc.

Passive investing in financial services

Apart from diversified equity funds, which have financial services in their portfolios, there are sectoral funds which invest only in financial services. However, most of these funds have failed to beat Nifty Financial Services TRI (see the chart below). In 3 out of the last

5 years, even most of the top quartile funds in the category were unable to beat the Nifty Financial Services TRI. Therefore, a passive exposure to this sector through ETFs or Index Funds may make sense.

Benefits of passive investing

• No unsystematic risks: Fund managers of active funds are overweight/underweight on some stocks relative to the index with the aim of creating alphas. This gives rise to unsystematic risks. ETFs and index funds aim to replicate the performance of the index. There is no unsystematic risk.
• Rule based Portfolio construction: Rule based selection and weighing ensures that indices are faithful representative of the intended objective with scheduled rebalancing of stocks ensuring inclusion of more relevant stock and exclusion of stock which doesn’t satisfy or capture the objective anymore
• Lower costs: Total Expense Ratios (TERs) of passive funds are much less than active funds. Costs are deducted in the NAVs of Mutual Fund Schemes. Therefore, a scheme with the lower costs will have higher returns for the same performance of under lying portfolio.

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