Bottom Fishing in IT Stocks? Here are 3 Mutual Funds to Watch out for...

Digitisation has turned out to be a highly rewarding theme for investors across the globe over the last 2 years.

Indian IT companies have remained at the forefront of a boom in tech spending. According to RBI, the export of IT services now accounts for 40% of India's total services exports.

In the pre-pandemic era, IT was considered to be a mature sector with a slow growth trajectory. Having said that, the frontline Indian IT companies always had a superior record of governance and cash flows compared to leading companies from other sectors.

In Q1FY22, the CEO of TCS opined that Indian IT companies were undergoing a multi-year technology up-gradation cycle.

And subsequent results in constant currency and Indian Rupee terms supported these claims. If high single-digit growth was considered a norm for the sector, companies not only started delivering double-digit growth but also revised their earnings guidance upwards many times.

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Not so surprisingly then, the Nifty IT Total Return Index (TRI) outperformed Nifty 50 TRI over the last two years with a noticeable margin.

As seen in Graph 1, a Rs 10,000 investment in the Nifty IT-TRI and Nifty 50-TRI two years ago, would have fetched Rs 25,021 and Rs 18,596 respectively.

Graph 1: Nifty 50-TRI Vs Nifty IT-TRI

Base: Rs 10,000
Data as of 25 April 2022
(Source: NSE, PersonalFN Research)

Midcap IT companies such as KPIT Technologies, Tata Elxsi, and Mindtree among others have massively outperformed their largecap peers such as Infosys, TCS, and Wipro.

However, of late, IT companies have witnessed sharp selloffs. In this phase, the frontline IT companies seem to have done better.

Table 1: Is the Best Time for IT Companies Over?

Company	1-Year Return	Fall from the 1-year High
Tata Elxsi	151.0	-11.3
TCS	14.1	-11.7
Infosys	17.1	-19.5
HCL Technologies	14.1	-19.7
Mphasis	64.6	-21.2
Mindtree	84.5	-25.2
Wipro	11.3	-26.6
KPIT Technologies	167.2	-29.7
L&T Technology Services	52.0	-32.2
L&T Infotech	24.4	-35.8

Data as of 25 April 2022
(Source: BSE, PersonalFN Research)

By doing a deeper analysis of the recent fall in the share prices of IT companies, we found that Foreign Portfolio Investors (FPIs) have been one of the major deciding factors.

Companies that have seen a large selling by FPIs in the fourth quarter have witnessed more downside pressure than others.

Table 2: Which IT stocks FPIs have Been Bullish on?

Company	FPI Shareholding (%)
	Dec-21	Mar-22
Tata Elxsi	11.93	13.15
Infosys	33.17	33.30
Mphasis	21.1	21.09
L&T Infotech	23.24	22.42
TCS	14.98	14.15
Wipro	9.34	8.11
Mindtree	15.72	14.40
HCL Technologies	20.43	18.97
L&T Technology Services	9.23	7.14
KPIT Technologies	20.38	17.10

(Source: BSE, PersonalFN Research)

As far as the financial performance of the Indian IT companies is concerned, a high attrition rate and a rising wage bill seem to be putting pressure on their profit margins now.

Nonetheless, Indian retail and High Net-Worth Individual (HNI) investors seem to be betting big on the technology sector.

From Rs 4,614 crore in March 2021, the total Assets Under Management (AUM) of actively managed Technology Sector Funds went up to Rs 19,786 crore in March 2022.

This is a sharp rise considering only 5 Technology Sector Funds on offer at present. This jump in AUM isn't entirely because of the market return. In fact, fresh inflows have been robust.

Table 3: Performance of Technology Sector and Thematic Funds has Been Impressive

Scheme Name	Return (Absolute %)	Returns (CAGR %)
	1 Year	2 Years	3 Years	5 Years	7 Years
ICICI Pru Technology Fund (G)	34.3	76.4	35.3	30.9	22.0
Aditya Birla SL Digital India Fund (G)	30.3	66.3	33.9	30.6	22.1
Tata Digital India Fund (G)	33.4	68.5	32.8	32.7	-
SBI Technology Opp Fund (G)	29.7	56.0	29.1	27.6	18.5
Franklin India Technology Fund (G)	10.8	44.9	23.5	23.0	16.9
NIFTY IT - TRI	26.2	60.0	27.2	28.2	18.4

Data as of 25 April 2022
(Source: BSE, PersonalFN Research)

Except for SBI Technology Opportunities Fund and Franklin India Technology Fund, the other three funds in the category have done very well compared to the Nifty-TRI across timeframes.

Should you invest in them now to take advantage of the ongoing lull in IT stocks?

Let's evaluate their performance closely...

Scheme #1: ICICI Prudential Technology Fund

Launched in March 2003, the ICICI Prudential Technology Fund aims to generate long-term capital appreciation by creating a portfolio that is invested in equity and equity-related securities of technology and technology-dependent company companies.

Table 4: Top-5 Stock Holdings of ICICI Prudential Technology Fund

Stocks	% of Assets
Infosys Ltd.	33.5
Wipro Ltd.	9.6
HCL Technologies Ltd.	9.6
Tech Mahindra Ltd.	8.9
Bharti Airtel Ltd.	6.2

Data as of 31 March 2022
(Source: ACE MF, PersonalFN Research)

As of 31 March 2022, the fund held 93.7% of its portfolio in equity and equity-related assets while cash and cash equivalent assets accounted for the remaining 6.3% of the fund's portfolio.

Although ICICI Prudential Technology Fund held 39 stocks, the top-5 stocks accounted for 67.8% of its portfolio as of 31 March 2022.

It's noteworthy that the fund has been also investing overseas allowing investors to play the technology theme on a bigger scale. These include exposure to companies such as Facebook, Salesforce, Adobe Systems, and Workday Inc.

ICICI Prudential Technology Fund has been trimming its allocation to midcap IT stocks such as Mindtree, Persistent Systems, Mphasis, and Sonata Software over the last 6 months. It has been adding largecap IT names such as Infosys, Wipro, and HCL Technologies among others to its portfolio.

Scheme #2: Aditya Birla Sun Life Digital India Fund

Launched in January 2000, Aditya Birla Sun Life Digital India Fund aims to achieve the long-term growth of capital by investing in technology and technology-dependent companies, hardware, peripherals and components, software, telecom, media, internet and e-commerce, and other technology-enabled companies.

The fund follows a bottom-up approach to stock picking and adopts a blend of value and growth style of investing.

Table 5: Top-5 Stock Holdings of Aditya Birla Sun Life Digital India Fund

Stocks	% of Assets
Infosys Ltd.	20.9
Tata Consultancy Services Ltd.	9.6
HCL Technologies Ltd.	9.0
Tech Mahindra Ltd.	7.1
Wipro Ltd.	6.0

Data as of 31 March 2022
(Source: ACE MF, PersonalFN Research)

As of 31 March 2022, Aditya Birla Sun Life Digital India Fund held 94% of its portfolio in equity and equity-related assets while the remaining 6% were in cash and equivalent assets. The fund held 39 stocks with top-5 stocks accounting for 52.7% of its portfolio.

Like, ICICI Prudential Technology Fund, Aditya Birla Sun Life Digital India Fund has been increasing the allocation to largecap IT stocks.

The fund has been paring its exposure to midcap IT, except that it has been adding L&T Infotech and L&T Technology Services to its portfolio on dips.

Exposure of the fund to overseas equity has remained constant over the last 6 months and includes companies such as Apple, Amazon, Accenture PLC, Adobe Systems, and Microsoft.

Scheme #3: Tata Digital India Fund

Launched in December 2015, Tata Digital India Fund aims to provide long term capital appreciation by investing predominantly in equity/equity-related instruments of the companies in the Information Technology Sector in India.

The fund holds the mandate to make some overseas investments in the technology space, as per the regulatory guidelines.

As of 31 March 2022, the fund held 94.3% of its portfolio in equity and equity-related assets of technology and allied companies. The remaining 5.7% were cash and cash-equivalent assets.

With a portfolio of 40 stocks, the fund holds a fairly diversified portfolio in the technology space wherein the top 5 stocks constitute 50.4% of the portfolio.

Table 6: Top-5 Stock Holdings of Tata Digital India Fund

Stocks	% of Assets
Infosys Ltd.	22.9
Tata Consultancy Services Ltd.	8.7
HCL Technologies Ltd.	7.0
Tech Mahindra Ltd.	6.8
Bharti Airtel Ltd.	5.1

Data as of 31 March 2022
(Source: ACE MF, PersonalFN Research)

A dominant portion of the portfolio is parked in largecap IT companies. But unlike its counterparts, Tata Digital India Fund has been increasing its exposure to midcap IT companies aggressively, taking advantage of the ongoing weakness in the sector.

The fund has been consistently increasing its stake in midcap companies such as Coforge, L&T Infotech, Mphasis, and Persistent Systems among others.

Besides, the fund has investments in foreign companies such as Amazon, Accenture PLC, Adobe Systems, Alphabet Inc., Cognizant Technology Solutions Corp., and Microsoft among others.

Outlook for the IT sector

Selling pressure in the midcap IT space despite strong March quarterly performance, perhaps suggests the markets have been factoring in most positives.

Furthermore, investors also seem to be worried about the impact of the talent crunch and rising wage bill. Valuations of most widely tracked IT companies are at a multi-year highs despite the recent correction.

In other words, although the sectoral prospects look bright, there is performance pressure on leading IT companies, especially in the midcap space.

Under such circumstances, conservative investors should avoid risking their capital with IT sector mutual funds and thematic funds.

As you must have noticed, the weightage of the top-5 stocks makes their portfolios skewed. Any stock-specific negative surprise may result in sharp losses.

That said, the long-term prospects of the IT sector appear bright on the back of robust trends in digitisation and automation.

Therefore, if you are an aggressive investor, i.e. have a high-risk appetite and a time horizon of 5 years plus, you may invest 5%-10% of your overall equity portfolio in Technology Funds.

Happy Investing!

Disclaimer: This article has been authored by PersonalFN exclusively for Equitymaster.com. PersonalFN is a Mumbai-based Financial Planning and Mutual Fund research firm known for offering unbiased and honest opinions on investing.