IT funds flavour of the season, but investors need to time entry, exit well

Whether IT sector will continue to outperform others will depend on a variety of factors
The Nifty Information Technology (IT) index, year-to-date, has risen 21.09 per cent compared to the Nifty 50’s modest rise of 2.27 per cent. Technology funds have given an average return of 19.05 per cent over this period. Over the past one year, the Nifty IT index has run up a staggering 38.31 per cent. Technology funds have outshone the index with an average return of 39.40 per cent. 

A key reason for the run-up in the IT sector is improved outlook for the companies within it. “The outlook for technology-related spend in the US and other advanced markets has improved considerably,” says S Naren, executive director and chief investment officer, ICICI Prudential Asset Management Company.

IT companies that were in a transition phase for the past couple of years are now delivering more positive news. “Companies whose dollar revenues were growing at 6-8 per cent are now guiding for growth of 8-10 per cent,” says Jinesh Gopani, head of equity, Axis Mutual Fund. Many Indian IT services have achieved the digital transformation they were working towards. “Market concerns around IT companies’ inability to transform and scale up their offerings and services in the digital space have receded due to visible improvement in this segment,” says Danesh Mistry, fund manager, Tata Mutual Fund.

Meanwhile, sectors that depend on the domestic economy have taken a beating. Hence, IT is looking good in comparison. "With the rupee depreciating and oil prices rising high, the domestic economy is looking weaker. Hence, many portfolio managers have moved to either neutral or overweight position on the IT sector,” adds Gopani. The rupee's depreciation has also boosted the prospects of this export-oriented sector. Companies in the IT sector are fundamentally sound with high standards of corporate governance. Generous dividends and periodic buybacks also make them attractive. 

Source: Ace Mutual Fund

Whether this sector will continue to outperform others will depend on a variety of factors. “If oil continues to hover at the same level or rises, IT will continue to be an attractive bet for portfolio managers, as it will help them diversify away from domestic economy-oriented sectors,” says Gopani. On the other hand, if the latter begin to do well or the rupee begins to appreciate, IT will no longer look as attractive. Gopani suggests that investors should keep an eye on IT companies' commentary about their prospects.

There are a few concerns about the sector still. One is the proposed changes to the H1B visa regulations, which could force Indian IT companies to hire more locally. This would mean higher costs and lower margins. Fund managers, however, do not regard this as a major concern. “There could be a temporary setback. In the case of any extreme development, the cost incurred is likely to be passed on to the customer,” says Naren.

Major Indian IT services companies have lagged behind global peers in latching on to new growth areas. Mistry, however, says that the recent results of IT companies show that the share of digital in their revenues is increasing. He adds that the ongoing efforts to reskill employees will also help these companies get more digital deals.

When choosing an IT sector fund, pay heed to a few criteria. Naren says, “The fund's long-term track record and pedigree should be your starting point." Mistry says that a technology fund does not just mean IT services companies. "Investors should look for a fund with a diversified portfolio of IT services companies, engineering and R&D companies, and product manufacturers," he says. Do not treat IT sector funds as buy-and-hold investments. Only savvy investors who are informed about the sector's prospects, and can time their entry and exit, should invest in these funds. Limit your exposure to these funds to 5-7 per cent of your equity portfolio.