Why Mutual Funds are holding onto loss-making new-age tech companies

New ideas, new business models

New-age tech companies aim to disrupt existing business models. For example, PolicyBazar changed the way people bought insurance policies. It is an online portal where potential policyholders can compare plans across insurance companies and buy the one that fits their requirements. Nykaa did the same for cosmetics and Zomato brought food on your table, from the choicest restaurants. So how can anyone not like these companies, asked many wealth managers.

Swarup Mohanty, CEO, Mirae Asset Investment Managers (India), said, “Like any other equity investment, investment in shares of new-age tech companies are done looking at the growth in the long term. Many of these have a large user base and they cannot be ignored altogether. We keep track of changes in business fundamentals and if we see improvements in the business, then we can add to our investments. Some of these may do well over the long term and some may not. Fund managers and our research function are continuously ramping up their efforts to pick future winners from this space.”

Fund managers are going beyond the conventional valuation tools while looking at these companies. “We have invested in only those stocks where the company has undisputed leadership and its business is positioned to grow fast. The profits may start rolling in much earlier than expected,” said a fund manager on condition of anonymity, justifying his investment in some of these loss-making firms.

Also read | Falling share prices, poor financials: New-age tech companies and pain in MF portfolios

From bad to worse

However, the game changed when interest rates started going up and tech stocks found it difficult to attract new investors. Some of them saw mounting selling pressure as stocks available for trade increased every time the lock-in period for anchor investors and pre-IPO investors ended.

“Most of these companies need funding to continue operations. As interest rates go up, they will find it difficult to raise money at valuations they enjoyed a year ago. Equity infusion in these businesses need to be carefully analysed in the context of valuations at which it happens, and the business fundamentals such as improvement in operating profit margins, management stability and how quickly the business achieve sustainable profitability,” said a fund manager who has not invested in the shares of these companies, asking not to be named.

What to expect going forward?

Given the profit pressures that most of these companies face and the need for private equity firms to exit, the fear on the Street about these stocks is real. Shares of Zomato, for instance, have come under selling pressure.

But some wealth managers see an opportunity. S Krishnakumar, director of Chennai-based Lion Hill Capital, said, “Tightening of valuations and investors looking for tangible cash flows can work as a self-correcting market mechanism which is right-pricing these companies, which were quoting at high valuations dictated by private equity investors, founders and management of these companies. As mutual fund managers develop better understanding along with the changing environment, the valuations are getting reset.”

Abhinit Kulkarni, founder and chief investment officer, Tequity Investing, a Mumbai-based SEBI-registered investment advisory firm, said, “Most of these companies are likely to be ‘story stocks’ being offloaded to retail investors. But it would be unfair to rule out investment opportunities in these new-age businesses.”

“Look for hunger of the management to keep growing, promoter’s skin in the game, ability to raise funds for growth and market share growth, which are essential ingredients for investment success in this space,” he added.

What should investors do?

As a mutual fund investor there is little you can do about your money being put into these stocks.

Deepak Chhabria, founder and managing director of Bengaluru-based wealth management firm Axiom Financial Services, expects Indian tech names to follow the broad global trend of falling prices as has happened in the US. “The factsheets of fund houses indicate that most diversified equity funds which hold shares of new-age tech companies have allocated very small amounts in percentage terms. If they are still holding on to their investments, then the impact may not be significant at the scheme level, even if these shares see selling around the ending of the lock-in period for pre-IPO investors,” he said.

Mutual funds’ diversified portfolios are better placed to weather turbulent times and some fund managers may actually end up buying these stocks if they get them at attractive price points.

Ravi Kumar TV, founder of Bengaluru-based Gaining Ground Investment Services, said, “Like any other equity investment, valuations hold the key to investment success. Most retail investors will find it difficult to time the entry and exit into these new-age tech companies which are yet to make meaningful profits. Some of these are still in losses. Let the more informed lot, the mutual fund managers, make that decision for you.”

Some of the fund officials Moneycontrol spoke with expressed their willingness to invest significantly in these new-age tech companies at right prices, even if they are holding small or no stakes as of now. Even in the last few months, some fund houses were seen buying shares of Zomato at lower levels, industry sources said. Going forward, if prices tank, fund managers may get another opportunity to buy the stocks cheaper if they are convinced of fundamentals.