Explained: Why mutual fund houses are pushing tech funds when IT stocks are in the doldrums?

Amidst the recent lacklustre performance of the information technology (IT) sector, mutual fund houses are introducing tech-focused funds. HDFC Mutual Fund on Friday, August 25, launched a technology fund, an open-ended equity scheme. The said new fund offer (NFO) will be available for subscription till September 5, 2023. Bandhan Nifty IT Index Fund and Quant Tech Fund's NFOs are also open for subscription currently.

Axis Nifty IT Index Fund and DSP Nifty IT ETF even recently reopened for continuous subscription.

The IT sector has faced challenges recently. The tech sector funds saw returns of 5.06 percent in the year ending August 21, 2023, in contrast to the 18.12 percent provided by multi-cap funds, according to Value Research. However, some experts believe that technology sector has the ability to demonstrate potential for growth and innovation in the long run.

Gopal Kavalireddi, Vice President of Research at FYERS, shed light on the situation. He highlighted that after a period of underperformance, technology sector stocks have started gaining attention from market participants.

"The adverse impact of central bank-initiated rate hikes on growth stocks' sentiment, cash flows, and valuations, particularly in the tech sector, was evident in 2022. However, the situation has evolved due to less dramatic effects of rising interest rates on economic activity and tech spending, combined with the pause in the interest rate cycle. As a result, IT stocks are regaining favour among value investors," he told CNBC-TV18.com.

Barring a few large-cap stocks, Kavalireddi said, most mid-cap and small-cap IT stocks demonstrated business resilience in their latest quarterly results, in terms of topline growth while managing the bottomline.

"This is being noticed by investors, as many segments of the market look overvalued and spotting bargain buys for the alpha generation is proving to be tough. While large-cap IT stocks remain exceptions, many mid-cap and small-cap IT stocks showcased business resilience in their recent quarterly results, manifesting growth in their topline figures while managing their bottomline. This observation has caught the attention of investors, especially since several market segments appear overvalued. Finding attractive bargains for generating alpha has proven challenging," Kavalireddi said.

In the past three months, the Nifty IT index recorded returns of 6.6 percent, surpassing the benchmark Nifty 50 index. Although trailing behind the Nifty Media index (34.3 percent return) and the Nifty Pharma index (21.3 percent), the Nifty IT index's outperformance has led asset management companies (AMCs) to launch technology-related ETFs and mutual fund schemes.

The DSP Nifty IT ETF was launched in July, with HDFC AMC and Quant AMC launching their tech funds opening for subscription in August. With these NFOs, a total of seven mutual fund schemes would be available for investors, catering to the technology theme.

Of the five schemes available to date, barring the Tata Digital India Fund, the rest were launched more than 20 years ago.

With  total assets under management (AUM) of Rs 26,000 crore, these five schemes have delivered decent returns to the shareholders consistently over various periods.

Experts believe that diversification is a key strategy in mutual fund investing. By offering a technology fund alongside other options, fund houses provide investors with a chance to balance their portfolios. This diversification reduces risk and helps investors take advantage of potential opportunities when the IT sector eventually recovers.

Additionally, the timing of launching tech funds might be seen as a tactical move. Launching such funds during a downturn could attract contrarian investors who see the current low valuations as an entry point, hoping to benefit when the sector bounces back. Another factor to consider is the cyclical nature of the technology sector. Launching a tech-focused fund during a consolidation phase could allow investors to capture future growth when the cycle turns positive again, experts felt.

With a total of seven mutual fund schemes catering to the technology theme, including the newly-launched offerings, Kavalireddi felt that opportunity for high returns over the next 3-5 years seems promising, particularly given the expanded and diversified presence of tech companies across sectors.

"This move aligns well with the Indian government's goal of increasing the technology and digital economy's contribution to 20-25 percent of the nation's GDP by 2025-2026. As the country strives to achieve a GDP target of $5 trillion by FY26, the tech sector's potential to contribute $1 trillion signifies substantial prospects for investors eyeing fresh investment avenues within the IT and related sectors," he told CNBC-TV18.com.

Abhishek Banerjee, Founder & CEO of Lotusdew Wealth & Investment Advisors Pvt Ltd, while acknowledging the unique features of the IT services sector, including its export-driven nature, steady cash flows, diversified exposure, and skilled workforce dependency, also emphasised caution — due to macroeconomic conditions.

Banerjee suggested that while certain NFOs may possess strong portfolios, a more concentrated approach towards the pharma sector could be preferable given the present circumstances.

"Our rationale includes factors like IT services are heavily skewed towards financial services as their customer, and the recent Fitch warning to US banks makes their growth vulnerable, there is upward pressure on wages and hence downward pressure on margins, higher than expected attrition has resulted in customer dissatisfaction and ultimately they have less operating leverage to similar export oriented services business like contract pharma manufacturers or speciality chemicals. Hence, while some of the NFOs might have a good basket, we prefer a more concentrated bet on pharma over IT services," he told CNBC-TV18.com.