Interest rate cuts, higher discretionary spending likely to boost tech funds

3 minutes of reading Last update: 12 Sep 2024 | 18:44 IST

Technology funds have been the best-performing category in the equity space recently. Of the category’s 35.2 percent average total return over the past year, 22 percent has come in the past three months.

“The structural opportunity for IT service providers in India remains large. Indian companies not only offer cost advantages but also provide value-added services and solutions to global companies. Technology funds allow investors to participate in this space, rather than just be users of it,” says Shibani Sircar Kurian, executive vice president and head of equity research at Kotak Mahindra Asset Management Company.

These schemes invest at least 80 per cent in technology stocks. As of August 31, 26 technology sector schemes had assets under management worth Rs 45,637 crore.

Impact of interest rate hikes

Technology funds have faced challenges in 2022 as rising interest rates have caused investors to dump tech stocks on fears of an economic slowdown. They have posted an average category loss of 23% this year.

Technology stocks have started to rally along with the broader markets in 2023, especially in the second half of the year. The upcoming interest rate cuts could boost the sector. “The rise in interest rates over the last few years has hurt performance, but the recent signals of rate cuts by central banks are helping to revive the sector,” says S Sridharan, founder and chief executive officer (CEO), Wallet Wealth.

Winds of change

The technology sector is diverse. Service companies have established strong footholds in markets like the US and Europe. Meanwhile, many technology companies in India are changing the way they do business. Many of those that are involved in new technologies have significant runways for growth.

“After a period of depressed discretionary spending, the IT services sector may be on the verge of a revival. Deal momentum over the last 18-24 months points to potential revenue growth. This is supported by cost optimization. US customers may be more willing to spend after interest 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 expected to drive medium-term growth in the sector. “Indian IT services players are well-positioned to capitalize on this opportunity and are investing significantly in building skills and capabilities and improving their AI-based offerings,” says Kurian.

Sectoral risks

As sector funds, technology funds carry concentration risk. “Tech stocks can be volatile. Investors should avoid overexposing their portfolios to any one sector and should look for diversification,” says Sridharan.

Investors should also pay attention to other potential risks. “A recession in the US, a delay in the US Federal Reserve’s rate-cutting cycle and a prolonged slowdown in Europe could all impact or delay the return of discretionary spending,” Kurian says.

Keep your exposure at a reasonable level

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

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

To avoid fund management risks, consider investing in an index fund or ETF tracking the Nifty IT Total Return Index (TRI).

First edition: 12 Sep 2024 | 18:40 IST