Mutual fund equity schemes which only invest in sectors such as banks and fast moving consumer products (FMCG) have emerged top performers across product categories in 2012. But these schemes face stiff challenges to repeat such outperformance in 2013. The outlook for bank shares will depend on the extent of policy rate cuts next year, while shares of consumer goods face a stiff task of justifying their steep valuations in the wake of a slowdown in consumption.
Banking and FMCG schemes have both returned roughly 47 per cent on an average since January. Though the banking schemes could not beat their benchmark, the Bankex, which rose 55 per cent, they comprehensively beat the key stock indices, Sensex and Nifty, and diversified equity schemes. FMCG schemes just about matched their benchmark's performance. The Sensex and Nifty have risen almost 25 per cent, while broader equity schemes grew 27-35 per cent so far in 2012.
While investors are optimistic about bank shares' prospects in 2013 on hopes of rate cuts, there are worries about asset quality.
"We expect asset quality to continue to deteriorate in India. With only a mild rebound in growth expected in 2013, we expect asset quality indicators to continue to weaken," said JPMorgan in its recent report on Asian banks. "With the highest NPL (non performing loans) ratios, the fact that it also has among the lowest capital ratios and lowest reserve coverage ratios adds to our concerns about the Indian banking system's fundamentals," it said.
What could come as a relief to banks is the potential rally in government bonds if the Reserve Bank of India cuts rates. This could result in gains from their bond portfolios that can be used to clean up their bad loan books.
"Interest rate cuts, likely in early part of next year, will fuel rally in bond prices," said Sujoy Das, fixed income head at Religare Mutual Fund.
Fund managers said private sector banks would be preferred over their public sector peers because of their superior asset quality.
"Mid-sized private sector banks have been able to manage to contain NPAs well," said Navneet Munot, chief investment officer, SBI Mutual Fund.
But, the optimism surrounding mergers and acquisitions among smaller banks following passage of the banking Bill has driven up their valuations significantly. As a result, shares of smaller banks could see limited upsides. "Large-cap banking stocks have room left for further upside," said Kaushik Dani, equity head at Peerless Mutual Fund.
Fund managers might struggle to churn out the returns they got from FMCG stocks in 2012 in the coming year. These shares could underperform the market over the next few months, on worries over steep stock valuations and signs of business slowdown, which was seen after the disappointing second quarter results.
The rally so far this year has driven up valuations of FMCG shares, measured by the price to earnings (PE) ratio, to 30-40 times estimated earnings. The Sensex is trading at an estimated PE ratio of 15 times. Analysts said these valuations are sustainable only if companies' earnings growth stays at 20-30 per cent. Second quarter earnings saw earnings growth fall below this number. Sunil Singhania, head of equity at Reliance Mutual Fund, had recently told Business Standard, he would rather wait for valuations in FMCG to come down to reasonable levels.