Non-Banking Finance Companies: The Preferred Choice for Mutual Funds in India
Mutual Funds in India
Non-Banking Finance Companies (NBFCs) have been gaining popularity among mutual funds as investment targets in India.
In recent months, mutual funds have shown a significant interest in NBFCs while reducing their exposure to private banking stocks. This article explores the reasons behind this shift and the potential benefits of investing in NBFCs.
The Interest Rate Scenario
Experts in the financial market believe that the interest rate cycle has reached its peak. As developed countries’ central banks begin to reduce interest rates, India may follow suit.
This could result in reduced liability costs for NBFCs, leading to increased profit margins. In response to this favorable market environment, mutual funds have been increasing their holdings in various segments of NBFCs, including housing finance, consumer finance, and microfinance.
Strong Loan Demand Across Segments
NBFCs are witnessing robust loan demand across various product categories, such as vehicle SME/consumer segment and gold finance.
As credit growth strengthens, analysts expect this positive trend to continue in the medium term. Moreover, there is optimism regarding the limited chances of significant non-performing loans in the coming quarters.
High Interest Rates and Profit Margins
One of the reasons why NBFCs are attractive to mutual funds is their ability to borrow at high-interest rates and subsequently lend at even higher interest rates.
For example, some NBFCs raise funds at an annual yield of 10% but lend at rates exceeding 14%. This difference allows NBFCs to maintain healthy gross margins compared to traditional deposit-taking companies that offer lower interest rates on deposits and charge similar or lower rates for loans.
Impact on Net Interest Margins
The increase in the cost of funds might lead to a slight decline in the net interest margin for some NBFCs. However, analysts anticipate marginal expansion in margins for other non-banking finance companies.
This will occur due to adjustments in their portfolios and an increase in lending rates. As a result, NBFCs that effectively manage the margin pressure may experience a re-rating in the market.
Bargaining Opportunities for Mutual Funds
In addition to the fundamental reasons for investing in NBFCs, mutual funds have also taken advantage of attractive stock prices through bargaining.
Large block deals in June involving Credit Access Gramin and Shriram Finance, for instance, presented discounted opportunities.
Notable mutual fund players, including Canara Robeca, Axis Mutual Fund, HDFC AMC, Aditya Birla Sun Life AMC, and Kotak Mahindra AMC, increased their stakes in these companies during this period.
Challenges and Potential Disruptions
Despite the optimism surrounding NBFCs, the sector may face challenges with the entry of Jio Financial Services (JFS).
The emergence of JFS could create upheaval in the industry, leading to increased competition. However, fund managers are advised not to make hasty decisions and instead monitor the situation closely.
Conclusion
Mutual funds’ growing interest in Non-Banking Finance Companies reflects the perceived opportunities and attractive prospects in this sector.
The potential benefits of investing in NBFCs include higher interest rate differentials, favorable market conditions, and attractive stock prices.
However, market players should also be cautious of potential disruptions due to new entrants like Jio Financial Services.
FAQs
What makes NBFCs attractive to mutual funds? NBFCs offer the opportunity to borrow at high-interest rates and lend at even higher rates, leading to healthy gross margins.
Are mutual funds optimistic about the credit cycle for NBFCs? Yes, credit growth has strengthened, and experts believe it will continue positively in the medium term.
What impact will reducing interest rates have on NBFCs? A decline in interest rates will lower the liability costs for NBFCs, leading to increased profit margins.
How have mutual funds benefited from investing in NBFCs? Mutual funds have found bargaining opportunities and invested in NBFC stocks at discounted prices.
What challenges does the NBFC sector face? The entry of Jio Financial Services may lead to increased competition and potential disruptions in the NBFC industry.
