Rate cuts and higher discretionary spending likely to boost tech funds

These schemes invest at least 80 per cent in shares of technology companies. As of August 31, 2024, 26 technology sector schemes managed assets worth Rs 45,637 crore.

Technology funds have been the best-performing category in recent times within the equity space. Of the total category average return of 35.2 per cent garnered by them over the past year, 22 per cent has come in the last 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 firms. Technology funds allow investors to participate in this space rather than just 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 shares of technology companies. As of August 31, 26 technology sector schemes managed assets worth Rs 45,637 crore.

Impact of rate hikes

Tech funds faced challenges in 2022 as interest rate hikes caused investors to offload tech stocks amid fears of an economic slowdown. They registered a category average loss of 23 per cent that year.

Tech stocks started moving up with broader markets in 2023, particularly during the second half. Impending interest rate cuts may boost the sector. “Rising rates in the past few years have hurt performance, but recent rate-cut signals by central banks are aiding the sector’s revival,” says S Sridharan, founder and chief executive officer (CEO), Wallet Wealth.

Winds of change

The tech sector is diverse. The services companies have established a strong presence in markets like the US and Europe. Meanwhile, many tech-enabled firms in India are transforming how business is conducted. Many of them, which deal in emerging technologies, have a significant growth runway.

“After a period of reduced discretionary spending, the IT services sector may be on the verge of a recovery. Deal momentum over the past 18-24 months points to potential revenue growth. This is supported by cost optimisation. US clients may show a greater willingness to spend after rate cuts and the presidential election, as consumer sentiment improves,” says Anil Rego, founder and CEO, Right Horizons.

The adoption of artificial intelligence (AI) and generative AI is set to drive medium-term growth in the sector. “Indian IT services players are well placed to capture this opportunity and are investing significantly to build skills and capabilities and enhance their AI-driven offerings,” says Kurian.

Sectoral risks

Being sectoral funds, tech funds carry 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 watch out for other potential risks. “Recession in the US, delay in the rate cut cycle by the US Federal Reserve, and a prolonged slowdown in Europe could impact or delay the return of discretionary spending,” says Kurian.

Keep exposure reasonable

Sectoral funds are best used in the satellite portfolio for tactical allocation. “Investors should limit exposure to tech funds to around 10-15 per cent and keep the remainder in diversified-equity funds,” says Sridharan.

Investors with high risk tolerance, who can handle volatility, may consider allocating a larger portion of their portfolios to IT funds. “The tech sector can be volatile, but offers significant growth potential,” says Rego.

To avoid fund manager risk, consider investing in an index fund or exchange-traded fund (ETF) tracking the Nifty IT Total Return Index (TRI).