Will Technology Mutual Funds Continue to Do Well in 2022?

January 21, 2022 Mutual Fund

Technology Mutual Funds, or IT Sector Mutual Funds, generated stellar returns in the calendar year 2020 and 2021, delivering average returns of 59.4% and 67.3%, respectively. ICICI Pru Technology Fund turned out to be the top performer in the category, generating 77.8% returns in absolute terms in CY 2021. Barring Franklin India Technology Fund, all the other schemes recorded growth of over 60% during the year 2021.

The technology sector has been one of the top drivers of economic growth in India. Notably, the Indian IT sector is one of the leading outsourcing destinations across the globe. The sector had received a further boost since the beginning of the pandemic as various activities, such as shopping, work, education, and leisure, shifted to digital mode.

The growing appetite for the adoption of new-age technology in India along with the government’s push for ‘Digital India’ has worked considerably well in favour of tech companies.

As a result, stocks in the technology and digital space have had a dream run in the last couple of years, which in turn benefitted Technology Mutual Funds that predominantly invest in IT services and related companies.

Table 1: Technology Funds delivered stellar returns in the last two years

Returns are Absolute (in %)
Direct Plan – Growth Option considered
(Source: ACE MF)  

The growth in technology companies has attracted investors towards Technology Funds. Consequently, the asset under management (AUM) of Technology funds has witnessed over 10-fold growth in the last two years. Infosys, TCS, HCL Technologies, Tech Mahindra, and Wipro are among the top choice of these funds.

Graph: AUM of Technology Funds soar high

(Source: ACE MF)  

Will Technology Mutual Funds continue to do well in 2022?

India’s IT ecosystem is growing at a rapid pace backed by various tailwinds. Indian IT firms also have the opportunity to benefit from emerging technologies such as, Cloud services, Fintech, E-commerce, Artificial Intelligence, Virtual Reality, Metaverse, and Blockchain technology.

IT bellwether companies like Infosys and TCS have shown encouraging earnings growth and are likely to do well in the foreseeable future as well. However from a risk perspective, not all IT and related companies may be well-paced to ride India’s tech boom. Some companies may report lower earnings growth in the coming quarters; hence, investors need to be aware that this could impact their share prices. Stocks of such companies may become range-bound or some could even decline in the coming months.

Another potential risk to the growth of Technology Funds is the high valuations at which most IT stocks are currently trading. The S&P BSE Teck index is trading at a significant premium compared to its 10-year average multiple (as seen in the table below). Besides, the expected interest hike in the current year is likely to put pressure on the equity market.

Table 2: Tech stocks are trading at high valuations

(Source: www.bseindia.com)  

At present, Technology Opportunities Funds or Digital India Funds run a risk of concentration with some of them holding as high as 18%-23% of their portfolios in just one stock. If the sector temporarily moves out of favour for any reason, Technology Funds will witness a significant drop in its NAV because there will be no sector diversification to cushion the fall.

Sector/Thematic funds like Technology Funds and Digital India Fund are high-risk high-return investment avenues. Timing the entry and exit is one way to reduce the risk and maximise returns from sector funds, but unfortunately, many individuals do not have the time and/or expertise to time their investment appropriately. It is important to note that not even savvy investors can accurately predict entry and exit points due to dynamic and volatile micro and macro environment.

Remember that, though sector funds witness periods of high growth, the downside on these funds can be higher than what most investors can handle. Therefore, sector funds are suitable only for investors who have a very high risk appetite.

[Read: Should You Invest in Sectoral and Thematic Funds for High Returns?]

Most diversified equity mutual funds already have substantial exposure to tech stocks along with diversification to stocks in other sectors. This reduces the concentration risk in their portfolio. So instead of investing in Technology funds, you would be better off investing in diversified equity funds since these funds have the flexibility to increase/decrease exposure to a particular sector depending on the outlook.

Some domestic mutual funds also offer diversification to global tech leaders such as Alphabet, Apple, Facebook, Microsoft, among others. Thus, you can select suitable schemes depending on your risk profile and investment objective.

If you do decide to invest in Technology Funds, ensure that your overall allocation does not exceed 10% of your equity portfolio.

To earn optimal returns, I suggest following the ‘Core & Satellite Approach’ –a time-tested investment strategy adopted by some of the most successive equity investors in the world.

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.

The ‘Core’ holdings should comprise around 65%-70% of your equity mutual fund portfolio and consist of a Large-cap Fund, Flexi-cap Fund, and Value Fund/Contra Fund. The ‘Satellite’ holdings of the portfolio can be around 30%-35%, comprising of a Mid-cap Fund and an Aggressive Hybrid Fund.

By selecting schemes wisely, structuring your portfolio between the Core and Satellite portions, you will be able to add stability to the portfolio as well as strategically boost your portfolio returns.

Note, Sectoral and Thematic Funds do not find a place in the ‘Core’ nor ‘Satellite’ portion of the portfolio.

Investing in well-managed diversified equity funds following the Core & Satellite approach will help you to get optimal diversification and will reduce the need to frequently churn the portfolio. To further reduce the impact of market volatility in the portfolio, I suggest taking the SIP route.

This article first appeared on PersonalFN here