Technology funds have been the best performing category of late within the equity space. Of the category’s average total return of 35.2 percent over the past year, 22 percent came in the past three months.
“The structural opportunity for IT service providers in India remains large. Indian companies not only offer a cost advantage but also provide value-added services and solutions to global enterprises. Technology funds enable investors to participate in this space rather than simply being its users,” says Shibani Sircar Kurian, Executive Vice President and Head of Equity Research, Kotak Mahindra Asset Management Company.
These schemes invest at least 80 per cent in equity of technology companies. As of August 31, 26 technology sector schemes managed assets worth Rs 45,637 crore.
Impact of rate hikes
Technology funds faced challenges in 2022 as rising interest rates caused investors to dump tech stocks amid fears of an economic slowdown. They posted an average category loss of 23% that year.
Tech stocks have started rallying along with the broader markets in 2023, particularly during the second half. The looming interest rate cuts may boost the sector. “Rising rates over the past few years have weighed on performance, but recent signals of rate cuts by central banks are helping the sector recover,” says S Sridharan, Founder and Chief Executive Officer (CEO), Wallet Wealth.
Winds of change
The technology sector is diverse. Service companies have established a strong presence in markets such as the US and Europe. Meanwhile, many Indian technology companies are transforming the way business is done. Many of them, working with emerging technologies, have significant growth potential.
“Following a period of reduced discretionary spending, the IT services sector may be on the verge of a recovery. Transaction momentum over the past 18-24 months points to potential revenue growth, supported by cost optimisation. US customers may show greater willingness to spend following rate cuts and the presidential election, as consumer confidence improves,” said Anil Rego, Founder and CEO of Right Horizons.
Adoption of artificial intelligence (AI) and generative AI is expected to drive medium-term growth in the sector. “Indian players in the IT services sector are well positioned to capitalise on this opportunity and are investing significantly to develop skills and capabilities and enhance their AI-driven offerings,” says Kurian.
Sectoral risks
Being sector funds, technology funds carry a concentration risk. “Tech stocks can be volatile. Investors should avoid overexposing their portfolios to a single sector and should ensure diversification,” says Sridharan.
Investors should also be on the lookout for other potential risks. “A US recession, a delay in the US Federal Reserve rate-cutting cycle and a prolonged slowdown in Europe could all affect or delay the return of discretionary spending,” Kurian said.
Keep exposure reasonable
Sector funds are best used in the satellite portfolio for tactical allocation. “Investors should limit exposure to technology funds to around 10-15 per cent and keep the rest in diversified equity funds,” says Sridharan.
Investors with a high risk tolerance who can handle volatility may want to consider allocating a larger portion of their portfolios to IT funds. “The technology sector can be volatile, but it offers significant growth potential,” Rego says.
To avoid fund manager risk, consider investing in an index fund or exchange-traded fund (ETF) that tracks the Nifty IT Total Return (TRI) index.
First published: September 12, 2024 | 18:40 hours IS
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