A lowdown on IT funds as a flurry of schemes pervades the mutual fund landscape

Count and list the new fund offers (NFOs) launched in one place and you will find how most asset management companies (AMCs) have launched their mutual fund products in the information technology space.

Though there were funds dedicated to the technology sector/theme, DSP Mutual Fund was the first to announce the launch of the DSP Nifty IT ETF on June 21, 2023. Then came Axis Mutual Fund with its Nifty IT Index Fund on June 27, 2023. 

Bandhan Mutual Fund quickly followed up with its Bandhan Nifty IT Index Fund on August 18, 2023, with both the Quant Mutual Fund and HDFC Mutual Fund houses launching Quant Teck Fund and HDFC Technology Fund, respectively on August 22 and August 25 this year.

The sudden focus on technology

Investors find it odd as the recent and continued flurry of new tech funds does not correlate with the common mindset of fund managers who tend to dwell on themes that are doing well or are expected to lend some temporary spurt in returns in the near future. However, the current race to launch technology funds has left investors asking, “What is broiling in the teichnology sector?”

Not that the technology sector has not performed well in the past. An assessment of the existing technology funds’ past performance reveals how some of them performed well before the tech sector started to bleed in 2022.

An evaluation of Nifty IT Index returns reveals the following returns from this sector from 2019 to date.

Investing in the technology theme

Technology sector funds represent a category of equity mutual funds that allocate a minimum of 80 per cent of their assets to the stocks of companies within the information technology (IT) sector. The IT sector encompasses businesses engaged in the development, manufacturing, and provision of IT products and services. Prominent IT firms in India include Infosys, TCS, Wipro, and HCL Technologies.

These funds can either be actively managed or passively managed. Actively managed funds involve a fund manager who handpicks the stocks for the fund's portfolio. On the other hand, passively managed funds mirror a specific index, such as the Nifty IT Index.

Investors with a belief in the undervaluation of the IT sector or its potential to outpace the broader market might find technology sector funds appealing. Nevertheless, it's essential to recognize that these funds are more volatile compared to diversified funds, making them unsuitable for all types of investors.

In most tech funds, most fund managers do not venture beyond the digital theme. Yet, you will come across many funds invested in stocks spread across various themes including telecom, consumer services, media-entertainment-publication, financial services, and other services.

For example, the SBI Technology Opportunities Fund has 57.41 per cent of the fund money in the “Computers – Software & Consulting” sector, 10.11 per cent in the “Telecom Services” sector, 5.87 per cent in IT-enabled services with the remaining money being put in other sectors.

Franklin India Technology Fund has 37.31 per cent of the money in the “Computers – Software & Consulting” sector with the remaining assets under management (AUM) spread across foreign equity, fintech, e-commerce, IT-enabled services, Internet & catalogue retail, Telecom – cellular & fixed line services and other diversified sectors and services.

Now compare the aforementioned funds with the ICICI Prudential Technology Fund which has 71.72 per cent of the AUM allocated to the “Computers - software & consulting” sector with the remaining money spread among the Telecom - cellular & fixed line services, foreign equity, refineries, heavy electrical equipment among others.

Why a sudden interest in the technology theme?

The technology sector is garnering interest like no other. This is inexplicable at a time when tech stocks are bleeding and are available at all-time low prices.

Tanvi Goyal, Founder, Wealth Aware explained, “According to a report by Goldman Sachs the Indian IT service companies have more than doubled their market share in the last 10 years. With low cost high-quality IT staff available in India, many Indian companies are investing in IT to make their operations more robust to ride the Indian growth story. The advent of generative Artificial Intelligence Tools is also going to be a factor in helping the revenue growth for the IT sector. However, as an investor one needs to look at the financials of a company rather than invest in the whole sector per se.”

Sahil Kapoor, Head of Products & Market Strategist, DSP Mutual Fund shared, “I am not sure why so many fund managers are finding it attractive. I am still cautious about investing in this sector as I feel that the margin pressures could come back. So, our approach is that the IT index is likely to correct more. If it corrects 10-15 per cent further, we will then take a relook at it. Lastly, because the service sector in the US economy is still slowing, and the technology company stocks are not trading at cheap valuations, I believe it is better to wait and watch.”

The series of interest rate hikes is still ongoing. The Federal Reserve has indicated its intention to persist with raising rates until inflation regains its two per cent target. Moreover, in the event that inflation renews its upward trajectory, there remains the potential for central banks to once again increase rates. Such a scenario could significantly impact international markets, consequently affecting the profitability of IT enterprises and impeding their prospects for medium- to long-term expansion.

Hiren Thakkar, Chartered Accountant Proprietor, Hiren S Thakkar & Associates responded, “If one has a five-year view, one can start accumulating IT stocks. Ideally, good businesses must be accumulated during their bad times gradually. However, the coming year can be tricky, and hence, one must exercise caution before investing.”

Dev Ashish, SEBI-Registered Investment Advisor and Founder, Stable Investor added, “It is very difficult if not impossible for most investors to figure out what is working and what is not working in favour of any given sector. Hence, most investors are better off not investing in sectoral/thematic funds or consciously trying to increase allocation to one particular sector at all. Their investment needs are sufficiently served via diversified equity fund categories like large-cap index funds, flexi-cap funds, large and midcap funds, etc. Increasing sectoral allocation based on one’s view is best left for investors with high-risk appetite, who have lots of patience and the knowledge as to why they want to take a concentrated bet in a given sector.”

Is the technology sector worth considering?

Numerous Indian IT firms are renowned for their effective leadership, above-average corporate governance, and a prolonged history of earnings expansion. These factors have rendered them appealing to investors, resulting in the IT sector significantly outperforming the Nifty50 Index over the past decade.

The current downturn within the IT sector could present a favourable opportunity to acquire IT stocks. Forecasts still anticipate sectoral growth in the forthcoming years, propelled by trends like the escalating adoption of digital technologies and the expansion of the Indian economy. Nevertheless, the sector is grappling with certain challenges, including escalating labour costs and intensifying competition from global counterparts.

For those contemplating investment in IT stocks, conducting thorough research and comprehending associated risks is crucial. Evaluating investment objectives and risk tolerance is equally important before arriving at a decision.

How much money should you invest?

Just because there are chances of growth in the technology sector in the future, this does not warrant investors to jump headlong into these investments. In the end, these are sectoral funds fraught with their own sets of risks and challenges. Investments in this sector yield cyclical returns, which means that investors must not continue to expect returns beyond a year or two, thus, hinting at average allocation preferred for medium-term investments.

Given that these are sector-specific funds, achieving profitable outcomes necessitates accurate timing for both entry and exit, alongside a willingness to endure heightened volatility during challenging periods. You must be sure of when you must enter such investments and when you must exit before market conditions start eating into your well-earned profits.

Suresh Sadagopan, Founder, Ladder7 Financial Advisories responded,” We generally do not suggest a sectoral play like tech. Even if we did it is for those willing to take higher risks - like those with aggressive risk-taking profiles. The percentage I would be not more than 10 per cent.”

Salonee Sanghvi, Founder, My Wealth Guide adds, “A sectoral fund is very concentrated and in the case of tech-themed funds, the top 10 companies comprise more than 70 per cent of the portfolio. Any sectoral fund requires you to be able to time the entry and exit perfectly. Large-cap and flexi-cap funds usually have 8-12% exposure to the technology stocks which is adequate enough for most investors. A separate fund is not required. For very aggressive investors who feel they can time it right, it could form a part of their satellite portfolio, with up to 15 per cent. Another way to play the theme would be investing in international funds investing in technology companies. NASDAQ has a lot of listed companies in various tech segments like hardware, social media, etc. that are not investible in India.”

Viral Bhatt, Founder, Money Mantra added, “There is no one-size-fits-all answer to this question, as the percentage of allocation one should decide while putting money in a technology-themed sector fund will vary depending on their individual circumstances and risk tolerance. However, some general guidelines to consider include your risk tolerance. If you are risk-averse, you may want to allocate a smaller percentage of your portfolio to a technology-themed sector fund. Technology stocks can be volatile, so if you are not comfortable with the risk of losing money, you may want to consider other investment options.”

Choosing between active and passive funds

There are both Nifty IT index funds and actively managed funds for investors to choose from. Both adhere to the technology sector though the former is a passively managed index fund while the other would be actively managed.

Deepali Sen, founder partner, Srujan Financial Services LLP (a Mutual Fund Distributor) said, “An actively managed IT fund over for an IT Index fund will be a function of higher volatility expectation and therefore appetite for the investor. So for an informed and seasoned investor, I would prefer the actively managed one as the risk-return would be higher for it.”

Rishabh Parakh, Chief Play Officer, NRP Capitals added, “First of all, both passive or an active fund in a particular sector is anyways riskier than an overall diversified fund. So, investing in an IT fund either way is a sectoral call and should be done only based on high risk-return proposition. Passive will have more stocks so it will offer a risk-reward proposition than an active IT fund.”

Investing in actively managed IT sector funds proves advantageous, as they tend to hold a superior position compared to passively managed index funds. Opting for a passively managed IT index fund provides investors with a cost-effective, uncomplicated, and convenient means to invest in predominantly large and mid-cap IT stocks. The primary objective is to capitalize on sector beta by engaging in a theme encompassing high-quality stocks within the identified sphere, coupled with ample liquidity.