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Is falling rupee making Tech funds attractive? - Outside View by PersonalFN

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Is falling rupee making Tech funds attractive?
Nov 24, 2011

India at present is the third largest outbound travel market in Asia Pacific region, and the number of Indians travelling abroad for a holiday is rising as per a report published by World Travel & Tourism Council (WTTC). But the trend may soon change, as the depreciation of the Indian Rupee may put pinch on the pocket, as you shell out more U.S. dollars for a holiday abroad.

Since August 2011, the U.S. Dollar has displayed a relentless up-move which has resulted in the Indian Rupee depreciating by 18.0% since August 2011, thus positioning it to level of Rs 51.3 as on November 18, 2011.

(Source: exchange-rates.org PersonalFN Research)

The depreciation of the Indian Rupee against the U.S. dollar has also got the Government in power to a worrisome situation, where even the RBI has resisted from controlling the falling rupee. The implication of such a weak currency, for the Government which has set a target of 4.6% for the fiscal deficit for the year 2011-12, could be:
  • Fiscal deficit target not being met
  • Bloated oil import bills
  • Imported inflation, leading to WPI inflation remaining stiff (as manufacturers of non-food items may increase prices of products, to compensate for the increase in import cost of peripheral goods)
  • Slowdown in consumption of imported goods
  • Slowdown in industrial activity
  • Slowdown in economic growth rate
But while all these worries do persist as the rupee continues to depreciate, exportersseem to be big beneficiaries of this - especially the companies in the Indian IT industry, whose revenue model is driven by export earnings.

Yes, in the recent past despite encouraging Q2FY12 earning numbers posted by most IT companies, stocks of most IT companies have been battered. Take for instance Tata Consultancy Services Ltd. (TCS); when the company announced its Q2FY12 results last month, the stock fell over 7.0% due to lower than expected earnings (Net profit was at Rs 2301 crore, up by 6.1% for the same quarter reported a year ago). Similarly with HCL; despite it recording a 50% rise in the Q2FY12 net profit, the stock lost over 8% on the day of result.

YTD performance of IT stocks in the current financial year
(Source: BSE India, PersonalFN Research)

Interestingly the same set of stocks had risen sharply when the first quarter results were announced in July. For example, TCS gushed 20% to reach its all-time high on better than expected results. This again, shows that in the short-term markets are purely driven by sentiments; because investors' punish a stock when the earnings from them don't meet market expectation. Some of you may be astonished to know that TCS took more than 10 years to beat its February 2000 peak. In other words it took more than 10 years for India's largest software company to record a new high.

The year 2000 is marked as a pinnacle of the dot-com bubble followed by a terrible bust which eroded investors' wealth. In 1990s, the U.S. had witnessed the internet boom with arrival of World Wide Web. There was an excitement in the equity markets where everyone were chasing IT stocks to build their portfolio, orders galore too flowed for Indian IT companies (from across globe) and outsourcing work followed as the BPO industry took birth in 1999.However, when the tech bubble was finally pricked in March 2000, it led to mayhem as almost all IT stocks crashed vertically in the U.S. and shares of Indian software companies too were no exception to this market upheaval. In fact many of the leading companies such as HCL, Mahindra Satyam and NIIT Technologies are still trading below their February 2000 peak. Mutual fund schemes too which were launched in great gusto evincing interest in the IT theme too lost steam, as the IT bubble went bust.

(Source: BSE India,PersonalFN Research)

But today, after a decade if we assess the contribution which the Indian IT industry has made, it has participated immensely to India's economic progress. It has witnessed astronomical growth in last two decades and a few million industry is now worth approximately $76 billion. Moreover, technological innovations and ability to execute critical projects has won Indian software companies respect worldwide. Also,it enjoys dominance in the sectorial breakup of BSE-Sensex and plays an important role in the index movement.

Interestingly, even during downturn of the Indian equity markets in 2008 (until March 2009), the Indian IT sector has displayed good resilience, along with a smart recovery during the upswing of the Indian equity markets, thus leaving investors' in the IT sector (who invested even during the high of 21,000 of the market) to gain.

BSE IT vs. BSE SENSEX
(Source:BSE India,PersonalFNResearch)

Performance across market cycles
Scheme Name Bull Phase Bear Phase Bull Phase
01-Aug-05
To
09-Jan-08
09-Jan-08
To
09-Mar-09
09-Mar-09
To
18-Nov-11
BSE IT 18.5% -47.1% 46.0%
BSE SENSEX 50.7% -55.4% 29.5%
(Source: ACE MF, PersonalFN Research)

So, say if one invested a sum of Rs 100 each in the BSE IT Index and BSE Sensex on January 9, 2008 the same would have yielded a sum of Rs 132 and Rs 78 as on November 18, 2011- i.e.an absolute return of +31.9% and -21.6% respectively.

How have technology mutual funds fared?
Scheme Name 6 Mths 1-Yr 3-Yr 5-Yr 10-Yr Std. Dev Sharpe Ratio
Average Returns of Tech Funds* -7.6 -10.4 29.6 2.6 19.7 7.89 0.24
BSE IT -6.7 -6.6 31.9 2.5 16.2 7.97 0.25
(NAV data is as on November 18, 2011. Standard Deviation and Sharpe ratio is calculated
over a 3-Yr period. Risk-free rate is assumed to be 6.37%)
(Source: ACE MF, PersonalFN Research)

However the performance of technology mutual funds reveals that, while from a 3-Yr return perspective the category average returns appears enticing, it has unperformed the BSE IT index. But being thematic in nature they have displayed more or less same volatility as the BSE IT index, and risk-adjusted returns too clocked by them have been in sync with that of the BSE IT index. This indicates that even though actively managed with a top-down approach, alpha (i.e. superior) returns have not occurred.

Y-o-Y performance of technology mutual funds
(Source: ACE MF, PersonalFNResearch)

The chart above reveals that not all technology mutual funds have fared in a same way despite investing in same the set of stocks; which in turn makes selection of sector funds even more difficult. It is noteworthy that technology mutual funds have fared well only when the underlying sector has experienced green shoots (such as the one the witnessed at present with weakening Indian Rupee resulting in better foreign exchange earnings by export oriented IT firms), but have completely lost steam when the going wasn't smooth for the sector. For instance, during 2005 and 2007 the Indian IT companies faced some troublesome issues such as managing high attrition rate, maintaining cost arbitrage and sustaining in an intensely competitive environment globally; resulted in them showing dismal performance which was completely overshadowed by the impulsive move of BSE SENSEX during the same time periods.

10 Year Performance of BSE IT vs. BSE SENSEX
(Source:BSE India, PersonalFN Research)

Hence if we as assess more than a decade long performance of the BSE IT index vis-a-vis the BSE SENSEX, it reveals that despite all the global economic worries, scams etc. faced by the Indian equity markets, the broader index - BSE SENSEX has outperformed the BSE IT index by a substantial margin. So say if one were to invest Rs 100 each in the BSE IT and BSE SENSEX on November20,2000, the same would have yielded a sum of Rs 179 and Rs 417 as on November 18, 2011 - giving an absolute return of +79.3% and +316.9% respectively.

What investors should do?

Those Indian IT companies which are run by the efficient managements will find out ways of dealing with challenges faced by the industry and IT may still remain a dominant sector in the Index. But a noteworthy point is that the IT industry derives 90% of its revenues by providing technological services to overseas clients - majorly from US and Europe, and is thus subject to pitfalls of broader global economic headwinds such as currency volatility, slowdown in western economies and lesser IT spending among others.

Also, investing in IT sector just because the Indian Rupee is depreciating against the U.S. dollar at present would be nothing more than speculation. Furthermore, betting on technology mutual funds may prove to be even more risky as these funds have put a very ordinary show so far. We believe that while you may like to take opportunities emerging from the IT sector and growth prospects which it has to offer, investing in an opportunities fund would be a prudent investment decision as it also imbibes in it the potential to take opportunities available in the other sectors / themes as well - thus making the portfolio fairly diversified and less risky. However, while selecting an opportunities fund care should be taken to select a fund with a proven performance track record, and one must always prefer a mutual fund scheme from a fund house which follows strong investment process and systems.

PersonalFN is a Mumbai based personal finance firm offering Financial Planning and Mutual Fund Research services.

Disclaimer:

The views mentioned above are of the author only. Data and charts, if used, in the article have been sourced from available information and have not been authenticated by any statutory authority. The author and Equitymaster do not claim it to be accurate nor accept any responsibility for the same. The views constitute only the opinions and do not constitute any guidelines or recommendation on any course of action to be followed by the reader. Please read the detailed Terms of Use of the web site.

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1 Responses to "Is falling rupee making Tech funds attractive?"

Arvind

Nov 29, 2011

TCS was not listed in 2000, so how come it is being said that it took 10 years to get back to that level?

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