Is it a good time to invest in tech funds?

The last 12 months have been miserable for mutual funds investing in India's tech stocks. Blame it on the entire tech sector losing almost a quarter pound of its flesh, falling 23.04 per cent, to be precise.

Even the big guns - TCS (Tata Consultancy Services), Infosys, Wipro - fired blanks.

Rising interest rates, geopolitical tensions, frothy valuations, were but some of the reasons why the technology sector fell in a heap. Naturally, mutual funds that invest in technology stocks - known as tech funds - also had an annus horribilis, a year to forget.

However, the technology sector's misfortune is a fund house's opportunity.

The tech hammering allowed fund houses to scoop up fundamentally strong and cash-rich IT companies at a discounted price.

But does that mean you, as an investor, should plunge into these tech funds right now, given they are at a low point?

Which way is the tech wind blowing?
Into the unknown.

While the current scenario offers attractive entry points, it is essential to recognise that the near-term outlook for India's technology stocks may not be entirely favourable.

And there is a possibility that these stocks could face further decline. Here's why:

• Fears over looming economic recession in the US: Banks have collapsed, consumers are spending less and factory output has slowed down, which is evidence of an economy feeling the after-effects of rising interest rates. To worsen matters, staff economists at the Fed privately anticipated "a mild recession" later this year, as per their minutes of the meeting released in April.
  Any slowdown is bad news for India's IT sector, as they are heavily dependent on providing tech services and support to the companies in the West.
• Disruptions caused by the rise of AI: Generative AI models such as ChatGPT can be bad news for Indian IT companies, with a JP Morgan report also stating that "ChatGPT will deflate legacy services the most". Such rapidfire shifts in the technology landscape can be detrimental to India-based IT companies in the long run, creating an additional layer of uncertainty.
• Valuations still remain punchy: Despite the storm in the last few months, the valuations of IT stocks remain on the higher side. A fund manager, requesting anonymity, also concurred, saying "they (the valuations) are still high compared to the pre-COVID era".

What should you do
Adopt a more prudent approach and consider diversified equity funds that offer a more balanced strategy.

Thematic/sectoral funds, such as tech funds, can be highly volatile, as illustrated by the graph below. These funds focus their investments on specific sectors, making them susceptible to downturns if that particular sector underperforms.

Diversified equity funds, on the other hand, allocate investments across companies irrespective of size and sector. This mitigates the impact of underperformance in a specific sector. By investing in such funds, investors can benefit from potential gains in other sectors that might compensate for any setbacks in some sectors.

Interestingly, many flexi-cap and large-cap funds (which are diversified equity funds) allocate 9-10 percent of their portfolio to IT stocks.

In conclusion, while it seems like an opportunity for tech funds to invest in IT stocks, the near-term outlook for the IT sector remains uncertain. To navigate these challenges, investors should be cautious and consider investing in a well-diversified equity fund instead.

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