Weekly Musings – NFO Pick (Bandhan Nifty IT Index Fund)

21 Aug 2023 , 06:35 AM

Our coverage has ranged across sectoral funds, active funds, passive funds, multi-cap funds, flexi-cap funds, multi-asset allocation funds and so on. In the current week, we are covering a fund NFO that is a sectoral fund but also a passive index funds. As the name suggests, Bandhan Nifty IT Index Fund will be benchmarked to the Nifty IT Index, which is a portfolio of some of the most influential IT (technology) stocks in India. The Bandhan Nifty IT Index Fund will be a proxy for the IT industry in India, but through the passive route. Here the focus of the fund manager will not be to beat the Nifty or to beat any specific set of stocks. 

About the Bandhan Nifty IT Index Fund NFO

The intent will be purely to mirror the Nifty IT index. That is why, the Bandhan Nifty IT Index Fund will ensure 85% to 90% of its corpus allocation to the constituents of the Nifty IT Fund with discretion of debt only for the balance portion. As an index fund (albeit sectoral index fund), the fund manager will focus on reducing the tracking error to the bare minimum so that the fund performance mirrors the Nifty IT TRI (total returns index) as closely as possible. The Bandhan Nifty IT Index Fund NFO has opened for subscription on August 18, 2023 and will close for initial subscription on August 28, 2023. Being an index fund, it will offer continuous purchase and redemptions at NAV linked prices once the allocation of units is completed; a process that normally takes around 15-20 days after closure of NFO. 

Who should invest in the Bandhan Nifty IT Index Fund NFO

Technically, the Bandhan Nifty IT Index Fund NFO is open for subscription to all eligible mutual fund investors who have completed their KYC and other formalities. However, from an advisory perspective, there are some things that investors should know before investing in the Bandhan Nifty IT Index Fund NFO. 

• Investors often assume that all index funds are the same, which is not true. A generic index fund like Nifty or Sensex may not have sectoral concentration risk. However, the Bandhan Nifty IT Index Fund NFO is a dedicated IT index fund, which means it is total concentration in the IT sector. Hence this fund will carry the risk of equities plus the concentration risk of being purely invested in the IT sector.

   

• The focused IT fund has the potential to generate higher returns over the longer time period. This has been empirically proven as we shall see later in our NFO analysis. However, suffice to say that the investors in this fund must have a higher risk appetite to absorb the risk of equities as an asset class, plus the sectoral concentration risk as well as a longer holding period to allow the sectoral index to decode business cycles.

   

• The Bandhan Nifty IT Index Fund NFO is an ideal product for investors looking to participate in a sector that is rapidly evolving. It is not that Indian IT sector has been around for over 40 years in India. But the shift from BFSI to SMAC and later to Digital-first in a span of the last 10 years, makes it one of the dynamic sectors in India. That also makes it a high risk sector since rapid evolution can also lead to obsolescence of the existing business model at a much quicker pace.

   

• The Bandhan Nifty IT Index Fund NFO is a good strategy for alpha generation over the long term. However, due to its concentration risk, it should ideally be part of the satellite portfolio rather than the core portfolio. This will ensure that the uncertainties associated with a sectoral index fund do not interfere with your long term goals.

   

• The investor must ensure that the Bandhan Nifty IT Index Fund NFO fits into their overall financial plan. That means; the inclusion of the Bandhan Nifty IT Index Fund NFO must not, in any way, impact the asset allocation of the investor in a meaningful way, either in terms of passive exposure or in terms of sectoral exposure.

With the backdrop of the five points above, investors can look to participate in the Bandhan Nifty IT Index Fund NFO.

Key highlights of the Bandhan Nifty IT Index Fund NFO

The Bandhan Nifty IT Index Fund NFO is a sectoral index fund, which is a passive approach to take exposure to the Indian IT sector. Here are some basic features of the NFO.

• The Bandhan Nifty IT Index Fund NFO opened for subscription on August 18, 2023 and will close for subscription on August 28, 2023, both days inclusive. This is an index fund, so the asset management company (AMC) will offer continuous sales and redemption of units at NAV linked prices on all working days.

   

• The Bandhan Nifty IT Index Fund NFO offers a wealth creation opportunity using a passive sectoral approach. As per the SEBI Risk-O-Meter, this fund is ranked as a high-risk fund due to its equity exposure as well as a very high concentration in the Indian IT sector. It means, returns could be uncertain and principle could be at risk.

   

• The primary objective of the Bandhan Nifty IT Index Fund will be to replicate the Nifty IT Index in the same proportion / weightage. The intent is to ensure that the returns on the fund (prior to expenses) mirror the returns of the Nifty IT index in the medium to long term. While the fund will endeavour to reduce tracking error to the bare minimum, the element of equity and sectoral risk still remains in the fund. Being a passive approach, the costs will be much lower compared to active funds.

   

• The Bandhan Nifty IT Index Fund performance will be benchmarked to the NIFTY IT TRI (total returns) index. As per SEBI regulations, mutual funds are required to benchmark performance with the TRI, which is the returns including dividends paid. This gives a better picture of fund performance. Entry loads are not imposed in India and this will fund will not carry any exit load.

   

• NFO subscriptions in the Bandhan Nifty IT Index Fund NFO can be made in minimum parcels of Rs1,000 while the systematic investment plans (SIPs) can be made in minimum parcels of Rs199 subject to minimum 6 instalments. This limit will apply in the case of systematic transfer plans (STPs) also.

The fund manager for the Bandhan Nifty IT Index Fund will be Nemish Sheth, who has extensive experience across ICICI Prudential AMC and IDFC AMC, the predecessor to Bandhan Mutual Fund.

Why IT is an exciting story in India

For a passive exposure to the IT index for the long term, the billion dollar question is what makes the IT sector attractive. This question specifically arises in the backdrop of the recent correction in IT stocks in this year after reports of a sharp fall in IT spending globally and pressure on IT project pricing. However, that does not change the macro story of the IT story. Here is why.

• Today IT services and IT platforms have taken over everyday life like never before. For example, in any normal day, everything from your morning news browsing to podcasts are driven by IT services. Today, people typically track their fitness on a smartwatch and work out of their laptops and notepads. Your lunch or dinner is implemented by food delivery apps and free time is for social media apps. Clearly, there may be hiccups, but the long term potential of this sector is huge.

   

• Here is a perspective of the IT sector in India, and you cannot miss its dominance. IT sector was 1.2% of GDP in 1998; it is 7.4% in FY22 and is expected to grow to 25% of GDP by FY25. India IT exports are to the tune of $178 billion per year and accounts for 51% of total services exports from India. India ranks Numero Uno in the global IT outsourcing market with a market share of an imposing 59%. It is also a socially significant sector as it employees over 50 lakh professionals today.

   

• According to Gartner estimates, the IT sector growth had tapered to 0.5% in 2022, but is expected to bounce to 5.5% in 2023 and to 8.6% in 2024. That is likely to open up a huge market for IT outsourcing and directly benefit Indian IT companies. The growth in 2023 and 2024 is likely to be driven by IT and software, where India is very strong in terms of its global offerings.

To sum it up, the pressure on IT stocks could be just a blip and can actually offer an interesting opportunity to accumulate value at low prices. 

Valuations of Indian IT sector also present a lively case

As Buffett says, at the end of the day, all investments boil down to valuations and the margin of safety. Let us look at how the IT valuations stack up and whether it makes a case for investing in an IT fund at this juncture.

• If one compares IT and BFSI in the Indian Nifty index, there is clearly a dichotomy. For example, financials contribute 31.9% of the PAT (profits after tax) of Nifty 50 companies but have a Nifty 50 weightage of 37%. In contrast, the IT majors contribute 16.5% of the profits of Nifty 50 companies, but have a Nifty weigh of only 13.2%.

   

• If you compare the average rolling returns of the Nifty IT TRI index and the Nifty TRI index, there is clear outperformance by Nifty IT index across different time frames. If we look at a 3-year, 5 year and 7-year horizons, then in each of these time frames, the Nifty IT TRI index has outperformed the Nifty TRI index by 500 to 600 basis points. There is a fundamental reason for this outperformance. For 2022, Nifty IT Index had ROE of 21% against 13% for the Nifty. Similarly, the dividend payout ratio for the Nifty IT index stood at 57% for Nifty IT index compared to just 29% for the Nifty.

   

• How has Nifty IT index performed vis-à-vis other sectoral indices. If you look at the last 10 years from 2013 to 2022, the Nifty IT index has been the top performer in 3 of these years and has been among the top-3 performers in 6 out of these 10 years. In 5 out of these 10 years, the Nifty IT index has beaten the Nifty by a huge margin. From a longer term perspective, if you look at 10 year CAGR returns, then IT has been the best performer with 17% CAGR returns. The second best, at a distance, is banks with 13% returns. Nifty has generated just 12% CAGR returns over the 10-year period. In the last 13 years, when IT gave negative returns in a year, it has bounced back with a vengeance. So, the negative returns of 2022 could just be that signal.

   

• Finally, let us look at Nifty IT valuations. From a P/E ratio of 38X in January 2022, the P/E ratio has slipped to below 25 in the year 2023, which is very close to its long term average P/E. Also, the average valuation premium of Nifty IT index to the Nifty has been around 16% over the last 18 years, but has now fallen to just 7%. The premium was as high as 50% in early 2022. That puts valuations in perspective.

The IT index currently comprises of 88% large caps and 12% mid-caps. For investors in the Bandhan Nifty IT Index Fund NFO, it provides the perfect combination of industry beta and alpha.