Bottom-fishing: Mutual funds launch tech funds as IT sector bleeds

Mutual Funds

Mutual fund houses are often criticised for launching schemes that track themes and sectors that have done better in the recent past. Such a strategy attracts significant inflows, as investors are willing to write cheques based on past performance. However, this time, mutual fund houses are launching schemes focusing on the information technology (IT) sector, which is not in the best of health. In the last year ended August 21, 2023, technology sector funds have given 5.06 percent returns compared to 18.12 percent given by multicap funds, as per Value Research.

At this juncture, the new fund offers (NFOs) of Bandhan Nifty IT Index Fund and Quant Teck Fund are open for subscription, while the NFO of HDFC Technology Fund (HTF) will open on August 25, 2023. Axis Nifty IT Index Fund and DSP Nifty IT ETF reopened for continuous subscription last month.

Tech sector funds

Like any other sector fund, these technology sector schemes invest at least 80 percent of the money in shares of companies in the IT sector. Thirteen technology sector funds manage assets worth Rs 28,864 crore as on July 31, 2023. Some of these are actively managed and also invest some money in IT stocks listed overseas. The passively managed schemes track the Nifty IT Index, which comprises 10 stocks from the sector. At present, there are 11 such funds. Nifty India Digital is a more diversified index consisting of 30 companies that represent the digital theme. The Tata Nifty India Digital ETF tracks this index.

ALSO READ: India’s 77th year of Independence begins: Are you financially free?

Most active fund managers specify their universe, seldom going beyond the broad theme of digital or IT. As per the presentation of HTF, the fund manager will build the stock portfolio from a universe of 121 stocks spread across IT, telecom, consumer services, media-entertainment-publication, financial services, and other services. These stocks are spread across the large-, mid-, and small-cap segments based on the market capitalisation of companies. S&P BSE Tech Index has a 79 percent weight in IT stocks, 18 percent in telecom stocks, 2.7 percent in media & entertainment, and 0.1 percent in consumer services.

Since these are sectoral offerings, the portfolios are generally concentrated and may have large allocations to individual stocks. For example, the Aditya Birla SunLife Digital India Fund has invested 22.8 percent of its corpus in the shares of Infosys. Franklin India Technology Fund, the oldest scheme in this space, has Zomato as its top Indian holding with 7 percent allocation.

Why tech sector funds now?

Nitin Rao, Chief Executive Officer (CEO), InCred Wealth, says, "Stocks in the IT sector have seen a correction and look attractive with a one-to-two-year timeframe."

ALSO READ: Business cycle funds are booming, but should you invest?

After closing at a high of 39,370 on January 4, 2022, the Nifty IT Index hit a low of 26,484 on July 15, 2022, and closed at 30,852 on August 22, 2023. The tech sector did extremely well globally when interest rates were cut to stimulate economic growth after the COVID-19 pandemic. The stock prices, however, were hammered out of shape, especially for loss-making tech-enabled companies, when interest rates started going up. Now, the interest rate hikes are expected to have come to an end in many key markets. At the same time, the medium- to long-term growth drivers are intact for these companies. However, the fears of a recession or slowdown are expected to bog down the earnings growth estimates.

Feroze Azeez, Deputy CEO, Anand Rathi Wealth, says, "It is a good time to look at IT sector funds as the valuations of Indian IT stocks are reasonable."

IT: When growth and quality come together

Many of the Indian IT companies are known for good management, better-than-average corporate governance, and long-term track record of earnings growth. Over the last decade, the IT sector has far outperformed popular measures of stock performance such as the Nifty50 Index. The current weakness can be used to scoop up IT stocks to benefit from the future growth.

"Despite continued global economic turbulence, worldwide IT spending is projected to increase by 5.5 percent to a total of $4.6 trn in 2023 and a 7-8 percent CAGR in USD from CY22-27, according to the latest forecast by Gartner. The software segment is expected to see double-digit growth as companies prioritise increased productivity and automation. With increased outsourcing, Indian IT services should grow at least in the high single digits in US dollar terms and double digits in rupee terms," says Sirshendu Basu, Head-Products, Bandhan Mutual Fund.

ALSO READ: Why are banks cutting down on free airport lounge visits?

Though the valuations are attractive, things may take some time to bounce back.

"The Indian IT services industry is facing near-term challenges due to the economic slowdown and weaker macroeconomic outlook. However, its long-term outlook remains robust, with the economy showing signs of recovery. We believe that the said recovery will begin in the second half of the year and FY24 will show strong revenue growth," wrote Omkar Tanksale, Research Analyst, Axis Securities, in his ‘Top Sector Ideas: IT Services’ research note for August 2023.

What should you do?

Since the IT sector may reward medium-term investors, it warrants an allocation. Before you decide to invest in an IT sector fund, check if your existing mutual fund schemes also invest in these stocks. For example, as a category, multi-cap funds allocate on average 7 percent of their money to IT sector stocks. Think about buying a tech sector fund if and only if you have a positive view of the sector. Since these are sector funds, you have to get both the entry and exit right to make money and also be comfortable with increased volatility in tough times.

Rao advocates staggering your investments in actively managed IT sector funds since these are better placed than passively managed index funds. "The consolidation phase may continue for a quarter or two," he adds.

And there are takers for index funds as well. Basu says, "A passively managed IT index fund offers investors a low-cost, hassle-free, and convenient option of investing in predominantly large and mid-cap stocks in IT. The idea here is to benefit from the sector beta by participating in a theme with high-quality stocks in the discovered space and adequate liquidity."

ALSO READ: Sweet medicine: Small-cap pharma and healthcare stocks that MF intake

When you think of IT stocks, the names of global majors also pop into your mind. However, experts advise against chasing these names. For now, it makes sense to avoid thematic schemes focusing on overseas stocks.

Azeez prefers to stick to existing IT sector funds that are primarily focused on Indian IT stocks. "Stocks of many global IT companies listed overseas may not be as attractive. Allocating money to high-beta overseas tech stocks can increase the risk for an Indian investor looking to reduce risk through diversification."

While investing in any sector funds, including tech sector funds, do not lose sight of your asset allocation.