HDFC Bank Dragging Mutual Fund Returns: Why Fund Managers Are Buying

HDFC Bank has become an uncomfortable holding for many mutual fund investors. The stock has fallen nearly 26% over the past year, and because it is one of the largest stocks in the Nifty 50 and appears across hundreds of mutual fund portfolios, its weakness has affected more than just direct shareholders.

For funds with meaningful HDFC Bank exposure, the stock has potentially been a drag on returns. This is particularly relevant for large-cap, flexi-cap and index funds, where HDFC Bank can account for a sizeable portion of the portfolio.

Yet mutual funds have not simply walked away. Their ownership in HDFC Bank increased from 26.66% in December 2025 to 29.54% in March 2026 and further to 30.62% by June. Mutual funds collectively also added around 55 crore HDFC Bank shares during 2026.

That creates the central question: if HDFC Bank has been hurting fund returns, why have several mutual funds been willing to increase their exposure? To understand that, we first need to see why this one stock matters so much to mutual fund portfolios.

Why HDFC Bank Has Such a Big Impact on Mutual Fund Returns

HDFC Bank is not a small position buried inside mutual fund portfolios. It is one of the most widely held large-cap stocks in the Indian mutual fund industry and appears across index funds, large-cap funds, flexi-cap funds and several other equity categories.

It also carries roughly a 10% weight in the Nifty 50, although the exact weight changes with stock prices and index rebalancing. This means passive funds tracking the Nifty 50 automatically have significant exposure to HDFC Bank.

For actively managed funds, the position can also be substantial. If a scheme allocates 7% or 8% of its portfolio to HDFC Bank, a sharp fall in the stock can meaningfully affect the scheme's NAV even if the fund owns dozens of other companies.

This explains why HDFC Bank's underperformance matters to mutual fund investors. What makes the story more interesting is what fund houses did while the stock was falling.

Mutual Fund Ownership Rose Sharply During the Correction

The ownership trend had already been moving higher, but the sharpest increase came during 2026.

Source: economic times

Between December 2025 and June 2026 alone, mutual fund ownership increased by almost 4 percentage points. Importantly, HDFC Bank was not rallying during this period. Aggregate MF ownership was rising while the stock itself remained under pressure.

So what were some fund managers willing to buy into? For that, we first need to understand what has gone wrong at HDFC Bank.

Why Has HDFC Bank Been Under So Much Pressure?

HDFC Bank's weakness is not due to one event. The main concerns are post-merger profitability pressure, weaker margins and governance and leadership uncertainty.

The HDFC Ltd merger significantly expanded the bank's loan book, which required faster deposit mobilisation. But the deposit mix matters. Costlier term deposits have been growing faster than low-cost CASA deposits, putting pressure on profitability. In Q1 FY27, HDFC Bank's NIM stood at 3.26%, while net interest income grew 6.7% and reported profit rose 5%.

So the market's concern is not whether HDFC Bank can grow. Loans and deposits are still expanding. The bigger question is whether the bank can return to the stronger profitability levels investors were used to.

Sentiment was further hit in March 2026 when then chairman Atanu Chakraborty resigned, citing practices that were not aligned with his personal values and ethics. The RBI later said it had no material concerns regarding HDFC Bank's conduct or governance, and external reviews did not substantiate broader concerns. Still, the episode added uncertainty, especially with CEO Sashidhar Jagdishan's term ending in October 2026.

Together, weaker margins, post-merger funding challenges and leadership uncertainty have weighed on HDFC Bank's valuation. Yet the core banking business continues to grow, which is where the mutual fund case becomes more interesting.

What Has Not Gone Wrong at HDFC Bank?

Despite weaker margins, HDFC Bank's core operating numbers remain healthy.

Source: screener

The bank is still growing loans and deposits at double-digit rates, while asset quality remains stable and capital levels are strong. So the issue is not that HDFC Bank's business has broken. The concern is that profitability has not yet matched the growth in its balance sheet.

This creates the key investment debate: are weaker margins a structural post-merger problem, or a temporary issue that can improve over time? That second possibility may help explain why some mutual funds have continued adding exposure during the correction.

What Could Some Fund Managers Be Seeing?

Mutual funds do not publish one collective reason for buying HDFC Bank, and different fund managers can arrive at very different conclusions. But the trade-off they are evaluating is fairly clear.

On one side are weaker margins, a more expensive funding mix, governance uncertainty and questions around how quickly profitability can recover. On the other is one of India's largest banking franchises, with double-digit loan and deposit growth, relatively strong asset quality and comfortable capital levels.

Valuation adds another layer. After the correction, HDFC Bank is trading at around 1.8 times book value, significantly below the roughly 2.8 to 2.9 times levels around which it traded historically.

That does not automatically make HDFC Bank cheap. If the bank permanently earns lower returns, it can deserve a permanently lower valuation. But if a fund manager expects profitability to gradually recover, the current valuation creates a very different risk-reward equation.

For a fund manager with a three-to-five-year investment horizon, the question therefore becomes: is the market pricing HDFC Bank as if today's weaker profitability will last much longer than it actually will?

Before interpreting rising MF ownership as proof that managers collectively believe so, however, there is an important distinction investors need to understand.

But Hundreds of Funds Holding HDFC Bank Does Not Mean Hundreds of Managers Are Bullish

HDFC Bank appears across hundreds of mutual fund schemes, but not all those holdings represent an active investment call.

A Nifty 50 index fund, for example, has to own HDFC Bank according to the stock's weight in the index. The fund manager cannot simply remove it because the stock looks unattractive. Passive ownership therefore tells us little about fund-manager conviction.

Even active ownership needs context. Suppose HDFC Bank represents 10% of a scheme's benchmark but only 7% of the actual portfolio. The fund still owns a large position, but the manager is actually underweight HDFC Bank relative to the benchmark.

So simply counting how many schemes hold HDFC Bank can be misleading. A better sign of conviction is whether active funds are increasing the number of shares they hold, raising the stock's portfolio weight or moving overweight relative to their benchmark.

And when we look at individual fund houses, there is clearly no single industry-wide view.

Mutual Funds Are Not Making One Collective Bet

Among the fund houses reported to have increased HDFC Bank exposure during 2026 were ICICI Prudential Mutual Fund, Nippon India Mutual Fund, SBI Mutual Fund, DSP Mutual Fund and PPFAS Mutual Fund.

At the same time, fund houses including Invesco Mutual Fund, Axis Mutual Fund and Sundaram Mutual Fund were among those reducing exposure.

So saying "mutual funds are bullish on HDFC Bank" would oversimplify what is happening. A better interpretation is that a meaningful section of the mutual fund industry has used the correction to increase exposure, while another section remains cautious.

Fund managers are looking at the same stock, the same problems and the same valuation and arriving at different conclusions. The disagreement becomes even more interesting when foreign investors are added to the picture.

FIIs Have Been Selling While Domestic Institutions Have Been Buying

HDFC Bank's shareholder mix has changed substantially during 2026.

Source: nse 

Foreign institutional ownership fell by almost 6 percentage points between December and June, while domestic institutional ownership increased sharply. Mutual funds accounted for a sizeable part of that domestic increase.

This effectively means domestic institutions absorbed part of the selling coming from foreign investors. It does not tell us which group will ultimately be right, since FIIs can sell for reasons ranging from global asset allocation to currency and India exposure.

Still, the divergence is noteworthy. The same stock that foreign investors have been reducing is simultaneously seeing increased ownership from domestic mutual funds.

That brings the discussion back to what actually matters for the mutual fund investor.

What Does This Mean for Mutual Fund Investors?

HDFC Bank's case shows why owning several mutual funds does not automatically mean better diversification. A Nifty 50 fund, large-cap fund and flexi-cap fund can all hold HDFC Bank, meaning one stock can affect several schemes in the same portfolio.

Investors should also avoid treating rising MF ownership as a direct buy signal. What matters more is whether active funds are increasing their shareholding and portfolio weight, while passive exposure should be viewed separately because index funds largely follow benchmark weights.

Going ahead, the key things to watch are HDFC Bank's NIM, deposit mix, loan growth, asset quality and profitability, along with whether mutual fund ownership moves higher from the 30.62% recorded in June 2026.

If profitability improves while active funds continue adding exposure, the case that some managers successfully used the correction to build positions becomes stronger. If margins remain structurally weaker, the lower valuation may simply reflect a new normal.

For mutual fund investors, the takeaway is simple: look beyond headline MF ownership, check portfolio overlap, and distinguish genuine active conviction from exposure that exists simply because a stock carries a large benchmark weight.