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PrimeInvestor Finance Squared smallcase

February 10, 2022

When we launched our Financial Disruptors portfolio on smallcase, India’s economy and capex cycle were in the doldrums after Covid, companies were preferring bond markets over banks to raise money and the market shares and traditional business models of mainstream banks and NBFCs were under siege from new-age fintech players, digital lending apps and neo-banks offering high-yield micro loans, pay-day loans, gold loans and property loans.

This left mainstream banks with not just sluggish loan book growth, but also intense competition for CASA. Ample liquidity injections from RBI prompted many mainstream banks to rely on lazy banking, simply sourcing money from the repo window and parking it in SLR securities to earn a slim spread.

However, recent trends indicate that tapping a wider opportunity in the finance space will pay off better than a focus on disruptors alone. Accordingly, we are broadening the scope of our smallcase to play the disruption where it unfolds as well as the larger lending space, plus the shift in financialisation of savings.

To reflect this capitalising on the multiple opportunities in the finance space as the Indian economy takes wing, we are renaming this smallcase to Finance Squared.

PrimeInvestor Finance Squared smallcase

Recent months have seen some of the trends turning, which change the landscape and opportunities in the finance theme.

  • Return of bank credit growth: Keeping up a pace of sustained recovery post-Covid, the economy and business activity are normalising quickly. With the RBI on a rate-hiking spree and market yields firming up more than bank lending rates, corporate appetite for bank credit has been returning.
  • RBI moves on digital lenders and fintech players: More importantly, RBI as the banking regulator seems to be having second thoughts about allowing digital lenders to proliferate and has been drawing strict boundary lines around non-bank and fintech players making inroads into the bread-and-butter activities of banks. 

This apart, the mindset shifts wrought by Covid, such as the financialization of savings, the take off of the equity cult in India and higher awareness about insurance products seem to be here to stay. Finance is the only sector guaranteed to capitalise on all the major engines of economic growth, be it consumption, capex, government spending or export growth.

With these trends now shaping the landscape of the finance sector, we have broad-based the mandate on our financials smallcase. From focusing on a smaller segment with the theme of disrupting mainstream players, we are expanding our portfolio to capitalise on the Indian economy finally taking wing.

Our Financial Disruptors portfolio, therefore, now dons the name of Finance Squared. It plays on 4 distinct trends. 

PrimeInvestor Finance Squared smallcase by PrimeInvestor

#1 Reviving credit demand

After languishing at growth rates of 4-8% between December 2020 and March 2022, credit demand has picked up to 12-13% in recent months. Bank credit growth in India has traditionally grown at a 1.5X multiplier to nominal GDP growth. But with many non-bank contenders in the fray, we expect banks to manage to grow their loan books in line with nominal GDP this time around. India’s nominal GDP growth is likely to be in the 14-15% range in the medium term, helped by reviving real growth and higher inflation.

Credit demand, which was mainly from individuals during Covid has also broad-based to include demand from services, industry and lately private sector companies reviving capex plans. This should lead to a revival in both income and profit growth for mainstream banks, as loan growth helps banks pass on cost increases and absorb legacy bad loans more easily.

While most banks will benefit from loan growth, we think that private banks with their superior digital interfaces and alliances with fintech players are much better-placed to capitalise on the upcoming opportunity than PSU banks. The favourable sectoral and economic tailwinds also offer conducive conditions for small and mid-sized banks, small finance banks, and those with a history of stress, to chart a turnaround.

#2 NBFC tailwinds

If domestic banks are sitting on peak asset quality, so are the large NBFCs. With the tailwinds to the economy returning, mainstream NBFCs engaged in retail credit, durables and vehicle loans, truck and logistics financing and MSME credit appear well poised too to deliver superior growth with improved spreads. There is also a set of niche affordable housing finance players that are growing at a much faster pace.

The bad loan spike on account of Covid has failed to materialise, and leading NBFCs have also benefited from RBI tightening the screws on capital adequacy, bad loan recognition, risk and liquidity management, to bridge the regulatory arbitrage between banks and non-banks.

With interest rates reviving, deposit-taking NBFCs are back in the race for deposits with competitive interest rates. Alliances with digital and fintech players are also set to help NBFCs in customer acquisition, expanding their addressable market.

#3 RBI crackdown

Bank and NBFC stocks were derated in the last couple of years on the belief that new-age fintech platforms, neo-banks and lending apps would eat into their share of young customers through their ease of use, good user interfaces and innovative product structuring. But RBI has lately made its intent clear on not allowing fintech players or unregulated entities to engage in lending, credit card issuances or other core activities of banks and regulated NBFCs.

In a bid to deal with customer complaints and bridge the regulatory arbitrage between banks and fintech players, it recently barred the loading of credit lines on mobile wallets and pre-paid instruments and decreed that only entities allowed to issue credit cards can offer credit through prepaid instruments. It also brought out a new set of rules for digital lending players that require all loan disbursals and repayments to be transacted only between regulated banks and NBFC and the borrower with any digital platform only playing a facilitating role.

While this is an evolving issue, it signals less disruption going forward to banks and NBFCs from fintech players encroaching on their turf. But we believe that banks who have not invested in digital interfaces or tie-ups, and those with glitchy user experiences (like PSU banks) will still be at threat of disruption.

#4 Financialization of savings

Many of the behavioural changes wrought by Covid are waning, but we believe that the change it has brought about in the Indian saver’s mindset is here to stay. Covid has created increased awareness about the importance of health and term insurance, and the need to own mobile financial assets and which can be readily liquidated which can be accessed in times of need.

The stock market’s resilient performance during Covid has played a role in the take off of the equity cult in India. While the total demat accounts in India stood at 3 crore prior to Covid and the number of mutual fund folios at about 9 crore, the rise in household surpluses during Covid and the reallocation of that savings pool to equities and MFs has lifted those numbers to 9.6 crore and 13.6 crore respectively. 

With these new investors having experienced the ease of transaction, liquidity and return potential of market-linked investments, they are unlikely to return to the safe haven of physical assets or even low return instruments like FDs in a big way.

Meanwhile, the Pradhan Mantri Jan Dhan Yojana has made great strides in achieving almost full coverage of Indian households with 46 crore households now owning bank accounts. The entry of these new savers into the formal banking system has already contributed materially to the rapid adoption of UPI payments and ecommerce, as also the use of Rupay debit cards. 

This creates a huge addressable market at the bottom of the pyramid for India’s microfinance firms, gold companies and retail financiers to tap. It also creates a large pool of customers for basic insurance, mutual funds, and other savings products.     

Our Finance Squared smallcase is suitable for aggressive investors seeking a high-beta exposure to the economy, willing to take on high return volatility.

PrimeInvestor Finance Squared smallcase by PrimeInvestor

FAQs: PrimeInvestor Finance Squared smallcase

What is the universe of stocks considered in Finance Squared?

NSE-listed financial companies from sectors covering banks, small finance banks, NBFCs, microfinance institutions and other financial services with market capitalization above Rs. 1,000 crore.

How are the stocks screened?

Key parameters are used to screen stocks in the universe to assess their prospects to make it to the shortlist and from there into the portfolio. These include, but are not limited to:

  • Earnings growth 
  • Yield on advances/NIM or margins
  • Return on assets 
  • Return on equity
  • Asset quality 
  • Capital adequacy ratio
  • Valuations

These parameters help assess fundamental strength. We look at aspects such as composition of loan book, domain expertise, size, yield, nature and characteristics of the credit cycle, risk in the different lending segments, and so on. We juxtapose this analysis with quantitative parameters to draw up our watchlist and build the portfolio.

How are the stocks weighted?

Growth, business fundamentals and financial track-record are the key factors considered while fixing the individual stock allocation in the portfolio.

How often is the portfolio rebalanced?

When a stock in the portfolio goes beyond our internally defined valuation comfort zones or external events reduce the potential growth for the stock, we may consider exiting or reducing it or booking profits. Similarly, a stock fitting this theme that holds new potential may enter this portfolio. Rebalancing of the portfolio will be done in the above instances on a quarterly basis. The portfolio may also be rebalanced between quarters when needed based on external events.

Some stocks in the portfolio have run up sharply. Should those be avoided?

No. PrimeInvestor Finance Squared is a weighted basket of stocks and is meant to be bought as a portfolio and not as individual stocks. Holding them as a portfolio will help reduce risk and optimise return. PrimeInvestor’s research team will keep a tab of stock valuations, growth and upside potential to decide if a stock needs an exit or weight reduced.

What is the tax impact on the portfolio?

The taxation is the same as tax on individual stocks. Stocks sold within a year will be taxed at 15% on capital gains and those held for more than a year at 10% (after the first Rs 1 lakh in long-term capital gains). Apart from this, you will be paying tax on dividend income (treated as other income) received from this portfolio, at your tax slab. TDS shall also be deducted on such dividend income at applicable rates unless you are submitting Form 15G/15H.

What is the cost involved in buying this portfolio?

On the research side, you will be paying PrimeInvestor a quarterly or annual fee as mentioned on the Smallcase portfolio page. On your brokerage platform, you will incur brokerage cost, securities transaction tax (STT) and demat charges, similar to buying and selling of any stock.

What returns should we expect from this portfolio?

The aim of this portfolio is to generate returns that beats the Nifty Bank index over the long term. However, this portfolio will go through ups and downs and may not beat the Nifty Bank at all times. As an aggressive growth portfolio, you can expect it to fall more than the Nifty Bank in a market correction. Do not expect positive or even double digit returns year after year. We do not provide any assurance or guarantee of returns on the portfolio.

How should I invest in this portfolio – through lump sum or SIP?

As a themed portfolio, we prefer that you invest lumpsum in this portfolio. However, if your investment amount is high and in several multiples of the minimum amount then you can consider spreading your investment over a few months.

Is there a cap or maximum amount that I can take exposure to?

There is no maximum limit to this portfolio. However, as a themed portfolio, it is good to restrict this to 5-10% of your overall equity portfolio.

Does PrimeInvestor offer other Smallcases?

Yes, PrimeInvestor offers a diversified Core & Satellite ETF Smallcase and a thematic Auto++ smallcase.

This Smallcase portfolio has delivered negative or poor returns since I bought it. Can I get a refund?

No, there are no refunds. Equity investing is risky and themed portfolios are riskier still, and will see declines from time to time. These are suitable only if you can stay invested over the long term. If you cannot tolerate sharp falls, it’s best to skip this smallcase and go for our Core & Satellite ETF smallcase.

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