Should you invest in technology sector funds?

By Ravi Samalad |  23-11-20 | 
 
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About the Author
Ravi Samalad is Assistant Manager - Editoral for Morningstar.in.

The pandemic has come as a boon for some businesses and has wreaked havoc for others. Stocks such as Facebook, Amazon, Apple, Netflix and Google, or more popularly known as FAANG stocks, did extremely well due to lockdown and work from home norm. Video conferencing tool Zoom became the go-to app for interacting with colleagues and families in this pandemic. Reflecting this trend, technology sector funds in India have delivered 41.02% return over the last one year, as on November 20.

Performance of tech funds

So far, most technology funds are actively managed. Recently, Nippon India and SBI Mutual Fund have launched exchange-traded funds, or ETFs, tracking the Nifty IT index. Let’s look at how the actively managed tech funds have performed over the last decade each calendar year.

As you can see from the above table, the performance has been chequered. Before you jump to invest in technology sector funds by looking at 2020 returns, let's understand how these funds function, their prospects, and the risks involved.

Options for investors

Broadly, there are two routes by which you can participate in the tech wave. The first route is through domestic sector funds and the second through ETFs/international fund of funds like Motilal Oswal Nasdaq 100 ETF.  The benefit of investing in international fund of funds/ETFs is that investors get exposure to stocks such as Alphabet, Netflix, Amazon, Facebook, Intel, Microsoft, Paypal, etc. While Nasdaq 100 has a higher weightage of tech stocks, the index also contains companies from other sectors.

Some Indian technology sector funds like Franklin India Technology Fund take exposure to global tech firms. The Indian Franklin Technology Fund invests in a global fund called Franklin Technology I Acc USD that invests in U.S. and non-U.S. companies expected to benefit from the development, advancement, and use of technology and communication services and equipment. Going ahead, more technology sector funds which were so far only focusing on Indian tech companies will start investing in U.S. tech stocks through existing funds.

Road ahead for Indian IT firms

Indian IT firms get a lion’s share of their revenues by exporting to banking and financial services, retail sector, among others. So, the fortunes of these U.S. firms could impact the revenues of Indian IT exporters. Further, the Biden government is also being hailed as positive for the Indian IT sector which expects liberalised immigration laws and visa programmes under the new administration. Factors such as corporate tax cut in U.S. and the resultant higher cash flows has led to U.S. firms to expand their spend on software/digitalisation which in turn has benefited Indian IT firms so far. What does the future hold?   “Some critical jobs which were warranted by clients to be done in their premises have been done well from a remote environment. This will lead to more offshoring. That’s where Indian companies stand strong. The market share of top five Indian IT services companies has grown from 15% to 25% in the last decade in comparison to the top five U.S. tech firms. This trend could accelerate in the future,” expects Meeta Shetty, Fund Manager, Tata Mutual Fund.  

Meeta is of the view that while companies such as Netflix and Zoom might see a slower growth post-pandemic, stocks such as Google, Amazon, Microsoft could benefit hugely from the shift towards cloud. Further, she believes that Google, Apple and Amazon could benefit from advertising revenues as consumer preferences shift from physical to digital shopping.

Now let’s look at the aspects that investors should keep in mind while investing in technology funds.

Risk

Himanshu Srivastava, Associate Director – Manager Research, Morningstar Investment Advisers India, says that technology funds could exhibit high risk and the decision to invest in them would depend extensively on investors risk appetite. “The risks are on multiple fronts. While currency risk is the most apparent one, the cyclicality of the sector makes it extremely volatile. And since it’s an export-oriented sector, regulatory issues in countries where they have businesses is another level of risk attached with such investments. Therefore, these funds are not for investors who do not have the stomach to withstand the volatility that tags along with these investments,” cautions Himanshu.

Bengaluru-based mutual fund distributor Srikanth Matrubai says that investors are better off investing in a typical diversified fund. “If the tech sector is looking good, the fund manager will make sure his fund has an exposure to tech stocks,” says Srikanth.

Also, by their very design, these funds typically have a high concertation risk too. For instance, on an average, 77.01% of the technology sector fund’s portfolio is concentrated in top ten stocks. Most funds are currently holding Infosys, TCS, HCL, Tech Mahindra, Wipro as their top bets.  High concentration risk could mean a higher drawdown.

SIP or Lumpsum?

Experts are of the view that the valuation of the Indian IT sector is currently higher than the long-term average and a correction cannot be ruled out. Since timing the entry could be difficult for most investors, experts suggest that a staggered approach to investing in sector funds is better. “As such, sector funds should be invested only with strong advice behind you (maybe an adviser or you yourself have a good hold on the subject). So, in case, any investor does feel attracted to a tech fund, he would be better off by going via the SIP route,” recommends Srikanth.

ALSO READ: Advisers caution clients lured by sector funds

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