• JULY 26, 2000

Software double-take

Fund managers are at it again. After having seen software stocks take a knock in March 2000, May-June witnessed fund managers doing a double-take on software stocks. Is this another case of lessons not learnt well enough?

Enough has been said about the software meltdown in March-April 2000 when we saw a huge 'correction' in software stocks. And the NASDAQ was made out to be the culprit, never mind if most of the people didn't even know the full form of the acronym. The meltdown was quite an experience for fund managers, traumatic, but enlightening. They were older and wiser. However, they didn't remain wise for long. For as March-April witnessed a dip in software allocations, May and June witnessed a resurgence in software allocations. All those debates about high software valuations took a backseat and the software frenzy seemed to have got the better of sound investment rationale, as fund managers began salivating at value opportunities and got into software stocks they had just dumped a few weeks ago.

We undertook a small study to estimate the magnitude of the resurgence in software allocations in May and June. Included in the study were diversified growth funds across several fund houses. Each of these is the flagship growth fund of that particular fund house. Needless to say the results of our study were revealing.

We selected five diversified growth funds - Kothari Pioneer Bluechip Fund (Kothari Pioneer MF), K 30 (Kotak Mahindra MF), DSP ML Equity Fund, (DSP Merrill Lynch MF), PruICICI Growth Plan (Prudential ICICI MF) and Birla Advantage (Birla Sun Life MF).

DSP ML Equity Fund is the only fund in our study that eschewed risks by taking a conscious decision to shirk software. That explains the progressive decline in software allocation from 43% in February to 34% in June. This is one fund that seems to have learnt it lessons really very well.

PruICICI Growth Plan is another fund that showed some resolve in shunning software after February (40.0%). However, except for a marginal rise in May to 34.2%, it has been mostly downhill settling down to 31.7% in June. It appears as if the fund was not willing to reduce exposure to software in a big way and at the same time nor was it sure of going all out after the value plays.

Except for these two funds, the other funds in our study seemed to have taken to software stocks in a significant way in May-June after dumping these stocks for most of March and April

So we have K 30's software holdings diving to 31% in May. But June witnessed a gradual firming up of holdings to 36.2%, giving the impression that the fund was not comfortable about a level less than 35% in software.

Birla Advantage was like something of an oddball in our study defying the trend witnessed in the mutual fund industry as a whole. Software holdings actually firmed up gradually from 63% in February to 70% in April before falling to 63% in May. But the fund sought to regain earlier levels (of around 70%) and there seemed like a build-up of software stocks to get to that level.

Kothari Pioneer Bluechip acted quickly during the meltdown. The fund witnessed the sharpest fall in our sample study from 40.1% in February to 28.3% in March. But April seemed to witness some kind of a take-off as the fund built positions in software progressively to 36.7% in June, which is not very far off from 40.1% in the pre-meltdown period.

So what does this study reveal to the investor? The implications of what we are witnessing right now has the potential of another setback, not very different from what we saw in March, when NAVs of growth funds crashed dramatically. Most funds would still have dark memories of the long queues of investors demanding redemptions, which was estimated to be in excess of Rs 25 bn in just one month. We are now witnessing a gradual buildup of software again. Although the levels are nowhere near the pre-meltdown levels, but any build up at this stage when software valuations are highly suspect is a matter of some concern.

Consider this, on July 11, 2000, India's two leading lights in software, Infosys and Satyam declared their 1QFY2001 results. While Infosys' net surged by 109%, Satyam wasn't too far behind with a 90% growth in net profit. Great results by any standards! And how did the market reward these two companies for their results? The reward if you can call it so, was a Rs 900 fall in Infosys in just about 8 days. Again, Satyam did not lag too far behind, as it crashed by over Rs 500 in less than a week. The reason behind the non-performance of these stocks was the fact that the markets had already factored in their results. So the results although exceptional absolutely, were considered ordinary relatively.

With this kind of a scenario, how many investors would feel comfortable holding software. Extending the same rationale, how many funds should be comfortable with an (increasing) exposure to software? And is the propensity of funds to time the market a good sign at all, regardless of the valuations?

Investors need to share that concern. Else a software double-take could result in a double-take of a whole lot of things, including NAV volatility, redemptions and financial heartache.

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