5 Equity Mutual Funds to Benefit from India’s IT and Tech Boom

August 28, 2023 Mutual Fund

Three years ago, when the COVID-19 pandemic gripped the world and lockdowns were imposed, the two sectors or themes that earned the attention of the market participants were ‘Pharma & Healthcare’ and ‘IT & Technology’.

Speaking of IT and technology, with a large section of the populace (barring the frontline workers) locked down at homes, the emphasis turned to Information technology, data consumption, and entertainment (while people aimed to stay safe at home).

So, broadly, technology as a theme boomed– grew leaps and bounds. Companies accelerated their digitisation of customer and supply-chain interactions as well as for their internal operations by three to four years, revealed a McKinsey Global Survey of executives. In other words, companies quickly adopted technology, proving to be an enabler.

Also, thanks to ‘Digital India’, a flagship programme of the Modi-led-NDA Government, with a vision to transform India into a digitally empowered society and knowledge economy.

Image: Key Vision Areas of ‘Digital India’

In July 2020, amidst the adversities of the COVID-19 pandemic, I wrote an article highlighting the opportunity to benefit from India’s IT and technology sector.

In FY 2022-23 (FY23), despite geopolitical tensions surfacing (with Russia’s invasion of Ukraine), inflation moving, and central banks increasing policy interest rates to tame inflation, India’s top 10 IT companies (namely, TCS, Infosys, HCL Technologies, Wipro, Tech Mahindra, L&T Infotech, Mindtree, Mphasis, Conforge, and Persistent Systems) collectively reported net profit of over Rs 1 trillion strengthening their position as a global technology powerhouse.

India’s software services exports reached USD 320 billion in FY23, and the surge in services exports was led by computer, IT and telecom-related services, as per the information disclosed by the economic arm of the Ministry of External Affairs, Government of India.

The share of the IT/Business Process Management (BPM) sector is currently around 7.5% of GDP.

Graph 1: Movement of S&P BSE TECk -TRI and Nifty IT -TRI v/s S&P BSE Sensex over 3 Years

Base = Rs 10,000
Data as of August 24, 2023
Past performance is not an indicator of future returns.
(Source: ACE MF, data collated by PersonalFN Research)

However, even since geopolitical tensions surfaced with Russia’s invasion of Ukraine, inflation moved up, and central banks turned hawkish, the S&P Nifty IT – TRI, particularly, has lagged. The Nifty IT – TRI has clocked -1.42% absolute returns, while S&P BSE TECk – TRI (which has a broad representation) has clocked +0.54% absolute returns (as of August 24, 2023).

Mutual fund houses are offering IT and Tech Funds Now

Amidst the correction witnessed by the Nifty IT – TRI and S&P BSE TECk – TRI, several mutual fund houses have launched IT or Tech Funds (passively managed ETFs and Index Funds and the actively managed ones), hoping to capitalise on the prospects of IT and Tech sector. They expect the cycle to turn in favour of the sector soon.

Table 1: IT and Tech Funds launched in 2023

Data as of August 24, 2023
(Source: ACE MF, data collated by PersonalFN Research) 

According to a NASSCOM report, Technology Sector in India 2023: Strategic Review, the industry is on the course of achieving the USD 500 billion milestone by 2030.

Grant Thornton, a firm that offers tax, audit, and advisory services, also foresees India’s technology industry to be driving innovation, employment, and GDP growth. The rise in fintech, ed-tech, and payment platforms is playing a pivotal role in the growth of the IT and Tech industry. Besides, the 5G revolution is powering the Internet of Things (IoT) opportunities.

Are valuations justified to invest in IT and Technology funds?

The graph below reveals that compared to the peak of January 2022, valuations look less expensive on the Nifty IT – TRI. A number of IT and tech companies — barring a few new-age ones — are perhaps justifying valuations if we consider the decent revenue growth and profitability.

Graph 2: Price-to-Equity Ratio of Nifty IT index

Data as of August 24, 2023
Past performance is not an indicator of future returns.
(Source: ACE MF, data collated by PersonalFN Research) 

If you wish to gain exposure to India’s IT and Technology sector, consider investing in equity mutual funds instead of investing directly in IT and Tech stocks. Doing so shall facilitate diversification and reduce the risk of investing in a single stock.

Note, that IT and Tech Funds are mandated to invest 80% of the assets into these sectors. Thus, they are categorised as Sector or Thematic Funds.

Some IT and Tech Funds are passively managed as ETFs and Index Funds (intended to generate returns in line with the underlying IT or Tech index), while others may be actively managed (intended to generate alpha, i.e. outperforming the respective IT or tech index).

But bear in mind, there is concentration risk. Currently, the top 10 holdings of Tech Funds are to companies such as Infosys, TCS, HCL Technologies, Tech Mahindra, Wipro, and a few among the new tech companies.

Table 2: Top 10 Holdings of Tech Funds

Portfolio data as of July 31, 2023
(Source: ACE MF, data collated by PersonalFN Research) 

How have IT & Tech Funds Performed?

With many of the top 10 IT companies done well on earnings, most Tech Funds over the longer term, i.e. 3 years, 5 years, and 7 years, have compounded money at a decent rate, outperforming the Nifty IT-TRI and the S&P BSE TECk – TRI.

Table 3: Performance of Tech Mutual Fund Schemes Across Timeframes

Data as of August 24, 2023
The list is not exhaustive, only actively managed Tech Mutual Fund schemes are considered.
The securities quoted are for illustration only and are not recommendatory.
Direct Plan-Growth option considered.
Returns considered are point-to-point and expressed in %.
Returns over 1 year are compounded annualised; else absolute.
Standard Deviation indicates Total Risk, while Sharpe and Sortino Ratios measure the Risk-Adjusted Return.
They are calculated over a 3-Yr period assuming a risk-free rate of 6% p.a
Past performance is not an indicator of future returns.
The table above is NOT a recommendation as such. Speak to your investment advisor for further assistance before investing.
Mutual Fund investments are subject to market risks. Read all scheme-related documents carefully.
(Source: ACE MF; Data collated by PersonalFN Research) 

SBI Technology Opportunities Fund has topped on 3-year returns, while on 5-year and 7-year returns it is Aditya Birla SL Digital India Fund that ranks first. These schemes have adequately compensated investors for the risk taken (as denoted by the high Sharpe Ratio).

SBI Technology Opportunities Fund has exposure to some heavyweight IT companies such as Infosys, TCS, Tech Mahindra, and HCL Technologies, plus has exposure to foreign equities such as Netflix and Microsoft. The fund mainly holds a largecap biased portfolio.

As regards, Aditya Birla SL Digital India Fund, it also has a largecap biased portfolio with many of the aforementioned companies, plus has exposure to new age technology-backed companies such as One97 Communications (Paytm), FSN E-Commerce Ventures (Nykaa), and Zomato. It also holds foreign equities such as Apple and Microsoft.

Table 4: Performance Across Market Cycles

Data as of August 24, 2023
The securities quoted are for illustration only and are not recommendatory.
Direct Plan-Growth option considered.
Returns considered are point-to-point and expressed in %.
Returns over 1 year are compounded annualised; else absolute.
Past performance is not an indicator of future returns.
The table above is NOT a recommendation as such. Speak to your investment advisor for further assistance before investing.
Mutual Fund investments are subject to market risks. Read all scheme-related documents carefully.
(Source: ACE MF; Data collated by PersonalFN Research) 

The performance across market cycles (bull and bear phases) of Tech Funds has been mixed. Some have fallen more during the bear phases, while others have protected the downside risk.

In bull phases, most tech funds have fared well. The reason for this is IT and Technology traditionally is cyclical sector. Meaning, that the revenue generation capability of the sector is closely linked to the business cycle and economic conditions.

In times when the undercurrents favour their business — as it did during the COVID-19 pandemic — or when the economy is booming, the IT and Tech sector would do well. But when there is fear of recession or slowdown — as witnessed last year and earlier this year — the IT and Tech sector usually does feel the impact.

Does it make sense to invest in IT and Tech Funds Now?

Well, the World Bank and the International Monetary Fund (IMF) at the start of the year warned of global recession in 2023.

The global economy has slowed in the first half of 2023 owing to the ongoing Russia-Ukraine war, elevated inflation, and central banks raising policy interest rates. It can be said that the global economy is dealing with severe stress and the risk is tilted to the downside.

Having said that, India is a “bright spot” (with a high GDP growth clocked amid the global challenges), and its IT and Tech sector is well poised as a global technology powerhouse. Many of the companies in this sector have credible management, follow good corporate governance practices, and their earnings trend over the long term has been encouraging.

In the last five years and decade, the IT and Technology sector has outperformed the bellwether, S&P BSE Sensex by a noticeable margin.

Graph 3: Nifty IT and S&P BSE TECk -TRI outperformed S&P BSE Sensex -TRI in the last 5 years

Data as of August 24, 2023
Past performance is not an indicator of future returns.
(Source: ACE MF, data collated by PersonalFN Research) 

However, in my view, diversified equity mutual funds can also help you benefit from the IT and Tech boom. All the diversified equity funds have a decent 9.09% exposure to IT and Tech Funds. Besides, they have exposure to other cyclical and booming sectors, which allow you to have diverse exposure.

Also, holding some of the best diversified equity mutual fund schemes that have adequate exposure to IT and Tech companies shall ensure that, if the sector does not fare well owing to unfavourable undercurrents, the performance does not take a major hit.

Want to know which are the best or the top diversified equity mutual funds to invest in 2023? Click here.

Also, watch this video:

As a strategy, I suggest following a ‘Core & Satellite Approach’. This approach is followed by even some of the most successful equity investors to build a robust all-weather portfolio with the best equity mutual fund schemes at a market high.

The term ‘Core’ applies to the more stable, long-term holdings of the portfolio, while the term ‘Satellite’ applies to the strategic portion that would help push up the overall returns of the portfolio, across market conditions.

Your ‘Core’ holding may comprise around 65%-70% of your equity mutual fund portfolio and consist of a large-cap fund, flexi-cap fund, and a value /contra style fund.

Whereas, the ‘Satellite’ holdings of the portfolio can be around 30%-35% comprising of a mid-cap fund, large & mid-cap fund, and an aggressive hybrid fund.

The Core and Satellite investment strategy may work for you in 2023 and beyond.

Who should consider investing in Tech Funds?

The IT and Tech Funds (or any sector/thematic mutual fund for that matter) aren’t for the fainthearted. Their concentrated portfolio places them at the higher end of the risk-return spectrum.

If the undercurrents for the IT and Technology sector aren’t favourable, it could weigh on the returns generated and may disappoint you. In other words, their fortunes are closely linked to how the IT and Technology sector performs.

At present, a possible recession or slowdown gripping the global economy later in 2023, geopolitical tension, cybersecurity threats, talent turmoil, and intellectual property theft are the key risks for India’s IT and Technology sector. Thus, although the IT and Technology sector holds a promising future with an emphasis on ‘Digital India’ plus a growing start-up ecosystem, semiconductor manufacturing, and artificial intelligence, one ought to be watchful.

Only if you are a very high-risk taker and can recognise macro trends and micro elements of the IT and Technology sector, you may invest a small portion (around 5-10%) of your total portfolio to such a sector and thematic fund, keeping a time horizon of around 5 years or more.

Keep in mind, before you add any mutual fund scheme, ascertain your risk profile, investment objectives, financial goals, the time horizon in hand to achieve the goals, and asset allocation best suited for you.

Be smart, yet a thoughtful investor.

Happy Investing!

This article first appeared on PersonalFN here