Mutual funds trimmed their exposure to PSU banks in May 2026, taking the sector's weight in their portfolios to an eight-month low of 3.4%, down 20 basis points from the previous month, according to Motilal Oswal's latest Fund Folio: Indian Mutual Fund Tracker.
Despite the monthly decline, the allocation remains 60 basis points higher than a year ago. The report also showed that PSU banks remained among the sectors most under-owned by mutual funds relative to their weight in the BSE 200 index.
The decline in mutual fund ownership has sparked debate over whether investors should interpret it as a cautionary signal.
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Rajesh Minocha, a Certified Financial Planner (CFP), Founder of Financial Radiance told ETMutualFunds that investors should avoid drawing conclusions solely from institutional ownership data.
"I don't think this is necessarily a warning sign. Mutual fund holdings represent only one datapoint. Investors should focus on fundamentals and valuation. A moderate reduction in institutional ownership may indicate normal consolidation rather than a bearish trend. Avoid blindly following the crowd, but also refrain from taking a contrarian stance without clear justification," he said.
Aarti Desikan, Executive Director at Anand Rathi Wealth Limited shared with ETMutualFunds a similar opinion that retail investors should not base investment decisions on changes in mutual fund ownership.
She further said that instead, they should focus on underlying fundamentals and their overall asset allocation strategy. While PSU banks may continue to benefit from favourable credit growth and economic activity, investors should avoid concentrated sector bets and prefer diversified equity funds which enables auto diversification across the sectors and categories and helps to avoid concentration and ride across market cycles.
Profit booking or sector rotation?
According to the report by Motilal Oswal Financial Services, the decline in exposure comes at a time when mutual funds have been increasing allocations to sectors such as NBFCs - non lending, capital goods, healthcare, cement, and e-commerce while reducing weights in PSU banks, oil & gas, technology, consumer and metals.
So with increase in exposure in other sectors and reduction in the PSU bank sector has raised questions about whether fund managers are booking profits, rotating into other sectors, or turning cautious on the sector's outlook.
Desikan said that in recent months, mutual funds have marginally reduced their exposure to PSU banks. The trend appears to be primarily driven by profit booking and portfolio rebalancing after the strong rally witnessed in PSU banking stocks.
She further said that after years of outperformance, valuations have become less attractive than they were earlier and active fund managers continuously rebalance portfolios based on emerging opportunities in broader markets. Therefore, the reduction in ownership should be viewed more as a tactical adjustment.
Minocha said that the recent decline appears to be driven by profit-taking and portfolio rebalancing following a strong two-year rally in PSU bank stocks and fund managers are reallocating capital to segments with more attractive risk-reward profiles and greater earnings visibility.
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Fund managers concerned over earnings outlook, asset quality, or valuations?
According to a report by ETMarkets, as the market transitions into a tougher macroeconomic environment marked by global uncertainty and intensifying deposit pressures, analysts caution that flocking to cheaper PSU stocks solely for their low valuations could backfire, pointing instead to larger private banks as the more compelling risk-reward play for FY27.
The report further said that Finance Ministry data shows aggregate PSU bank net profit rose 11.1% year-on-year to a historic high of Rs 1.98 lakh crore, the fourth straight year of aggregate profitability for the sector.
The report by ETMarkets further highlighted that the gross NPA ratio fell to 1.93% as of March 31, 2026, and the net NPA ratio to 0.39%, levels that now match or beat several private sector peers. Every single PSB maintained a provisioning coverage ratio above 90%. Fresh slippages continued to decline, with the slippage ratio at 0.7% for FY26, and total recoveries, including from written-off accounts, reached Rs 86,971 crore.
Minocha said that this appears to reflect valuation caution rather than concerns about asset quality and PSU banks have strengthened their balance sheets, but future returns will likely depend more on earnings growth than on further valuation re-rating.
Desikan said that most PSU banks have strengthened their balance sheets by lowering non-performing assets, improving provisioning coverage and maintaining healthier capital positions. The moderation in mutual fund ownership likely reflects normalising earnings expectations and valuation considerations rather than deteriorating fundamentals," she said.
Exposure in portfolio
The weightage of this sector in BSE 200 was recorded at 3.8% in May and some fund houses such as Aditya Birla Sun Life Mutual Fund, HDFC Mutual Fund, Kotak Mutual Fund, and SBI Mutual Fund had an allocation of more than 3.8% in the similar period.
There are around 10 funds based on PSU banks which includes passive funds such as ETFs and index funds. Out of these 10 funds, eight have completed one year of existence and DSP Nifty PSU Bank ETF gave the highest return of 23.84% in the last one year, followed by Mirae Asset Nifty PSU Bank ETF which gave 23.72% return in the same period.
Only three funds have completed three years of existence in the market and ICICI Pru Nifty PSU Bank ETF gave 28.86%, Kotak Nifty PSU Bank ETF and Nippon India ETF Nifty PSU Bank BeES gave 28.66% and 28.65% returns respectively in the last three years.
Desikan said that going forward we expect the PSU banking sector to remain constructive and credit growth is expected to improve gradually, supported by an interest rate environment and economic activity. The asset quality trends are also expected to remain stable on both a QoQ and YoY basis, reflecting the healthier balance sheets of most PSU banks.
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She further said that when it comes to investing in the PSU banking sector we suggest investors avoid investing in sectorial/thematic space as they often tend to undergo cyclical performance which requires tactical entry & exit to ride the performance which is not suitable for regular investors and recommend investors to invest in diversified equity funds which enable auto diversification across the sectors and categories.
To this, Minocha said that PSU banks may be better suited as satellite positions within a diversified portfolio rather than as core holdings, the outlook remains positive, supported by credit growth, improved asset quality, and stronger profitability. However, after the recent rally, future gains are likely to be steadier and more stock-specific rather than driven by broad momentum.
(Disclaimer: Recommendations, suggestions, views and opinions given by the experts are their own. These do not represent the views of The Economic Times)
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