Technology funds have made more money for investors than any other mutual fund category in the past year. A decline in the rupee against the dollar to record lows and strength in the US economy triggered a rally in technology shares, such as TCS NSE 3.81 % and Infosys NSE 3.07 %, earlier ignored by investors amid worries about insipid growth prospects.
In the past year, the fund category has returned an average of 47%, topping the returns charts across mutual fund categories, according to Value Research. Funds investing in foreign equities are a distant second, returning 13.3% in a year, as against the Nifty’s 12.2%. However, three of the five funds in the category have not been able to beat the benchmark, the Nifty Information Technology (IT) index, which has gained 50% during the past year.
Investors are betting that improved growth in the US economy would lead to an increase in orders for Indian IT services companies.
Gopal Agrawal, senior fund manager at DSP Mutual Fund, said, “Better prospects of the banking, financial services, insurance (BFSI) and energy industries with larger orders and better contract prices have played a key role in improving the earnings outlook for the sector.”
The 14% fall in the rupee against the dollar in 2018 has also played a part in increasing the earnings expectations for IT services companies whose receipts are usually denominated in foreign currencies.
“Until this year, the rupee had been more or less flat for three years. The recent rupee depreciation has led to earnings upgrades for IT companies” said Mahesh Patil, co-CIO of Aditya Birla Sun Life Asset Management Company.
Fund managers said the prospects of IT companies have improved also because of the investments in made in reskilling to address the growing demand for digital services including machine learning, automation and data analytics.
Among top IT shares, TCS has gained 65.1%, Infosys has risen 61.1%, HCL Technologies has advanced 23.3 % and Wipro has moved up 14.6% in the past year. The gains in some smaller software companies have been sharper, with L&T Technology gaining 123.7% and Mindtree rising 115%.
The rally in the shares has made some of them expensively valued, which could limit their upsides, warn fund managers.
“Valuations in the IT sector are on the higher end of the spectrum considering the growth they are going to exhibit,” said Patil. “I expect the returns on these stocks to be moderate because of higher valuations.”
For instance, the price to earnings (P/E) ratio that L&T Tech and Mindtree are trading at is 81% and 34% higher than their five-year average P/E, respectively. TCS, India’s largest software company, is trading at a P/E of 30.4 times, well above its five-year average of 22.5 times.
Some fund managers remain bullish about larger technology companies because of their stronger growth prospects.
“Although relatively smaller IT services companies are growing fast, I think they are already being priced for that growth. I believe there are still some opportunities in the large cap services space,” said Danesh Mistry, fund manager of Tata Digital India Fund, which returned 63% in the past year.
Companies in the engineering research and development are also interesting investment opportunities for the next two years, said Mistry.
“If the expected order flows from the BFSI segment did not materialise, it would impact stock prices negatively,” said Mistry.