Weekly Musings – NFO Pick (Nippon India Nifty IT Index Fund)

5 Feb 2024 , 06:50 AM

WHAT EXACTLY IS THE NIFTY IT INDEX FUND

Like any passive fund, the Nifty IT Index Fund is a passive approach to participating in the sector fund. In any sector fund, that is the concentration risk since the portfolio is focused on just one sector predominantly. However, the passive approach of using IT index fund offers two advantages. It offers a portfolio that is automatically diversified and thus negates the risk of individual stock selection. Secondly, being a passive fund, the costs are intrinsically low and this ensures that better ROI on the investment.

The Nifty IT Index Fund invests in a portfolio that exactly replicates the Nifty IT index. The effort is not at stock selection and only at minimising the tracking error. Despite being an index fund, the Nifty IT Index Fund would still classify as a high risk fund due to its equity bias and the concentration in IT stocks. It will be open ended, offering continuous buy and sell at NAV linked prices. Most passive funds are intrinsically transparent as they purely replicate an underlying, and the constituents are already public information.

GROWTH TRIGGERS AND CHALLENGES FOR IT SECTOR IN INDIA

Let us look at the major growth triggers for the IT sector first.

• Globally, industries spend about 5% to 10% of sales on technology. The total global IT pie is $1,900 billion, of which nearly 40% is outsourced. India alone accounts for 58%  of global IT spend. India dominates IT outsourcing.

   

• India has a diversified sectoral and geographical mix. Today, only 62% of IT revenues comes from the US, with 17% from UK and Europe at 11%. In sectoral mix, BFSI is 41%, telecom is 18%, manufacturing 17% and retail 10%.

   

• In the last 10 years, the triggers for growth have shifted from traditional BFSI outsourcing to digital stories. Now, digital is 30% to 40% of the India story and India is foraying into artificial intelligence, machine learning, IOT, blockchain etc.

Let us now turn to the recent challenges for the Indian IT industry.

• When the US embarked on rate hikes, many large companies embarked on cost cutting. IT budgets were the first casualty, although that is now known to be recovering.

   

• Indian IT is facing competition, not only from other countries, but also from the consultancy firms that are now offering more comprehensive solutions

   

• India has a massive challenge in terms of filling up the skill gaps that are in tune with the changing face of IT industry in India

Despite these challenges, the IT story looks intact in the Indian context.

WHY THE FUTURE BECKONS INDIAN IT STOCKS?

In a globally challenging environment, there are several factors that are also working to make Indian stocks more valuable in the future.

• The soft landing of the US economy (controlling inflation even amidst strong growth) is a major trigger for the sharp recovery in IT spending.

   

• Indian IT companies (both large caps and mid-caps) are winning a lot more of mega deals which not only outsource, but offer comprehensive end-to-end solutions.

   

• Within the IT sector, the sector shift is likely to help as TMT and BFSI are likely to grow the fastest. These are the areas where India has a traditional advantage.

   

• Indian IT sector does not show vast variations between valuations of large cap IT and mid-cap IT. However, the recent edge of mid-cap IT, makes bigger names reasonable.

   

• The valuation premium enjoyed by Nifty IT over Nifty index is stable over 10 years. However, the current P/E of IT index at 29.7X is lower than the 2021 peak of 39.6X.

These factors do make a case for investing in the IT story from a futuristic perspective.

HOW HAS THE NIFTY IT INDEX PERFORMED IN INDIA

In 2023, the Nifty IT index had outperformed the Nifty by 600 bps, despite the headwinds. Here is how the IT sector looked from a historical perspective.

• A sum of Rs1 lakh invested in the Nifty IT TRI in early 2000 would have grown to Rs36 lakhs. That is CAGR returns of 15.7% over 23 years; bettering Nifty by 160 bps.

   

• If you consider rolling returns of the Nifty IT index over the last 10 years, the probability of the IT index outperforming the Nifty is over 59%. That is quite impressive.

   

• The most interesting part is the correlation between the IT index and the Nifty index. It is high in the short term, but very low in the long term. Correlation is 0.73 over 1 year, but falls to 0.28 over 10 years and 0.15 over 15 years; making it a solid risk diversifier.

   

• Nifty IT index has outperformed the Nifty in 11 out of the last 15 calendar years. Every underperformance year is followed by a year of sharp outperformance by the IT index. That also offers a good bottom fishing opportunity in bad years.

   

• In most years, when the market momentum has been favourable, the Nifty IT index has substantially outperformed the IT index. That is typically in bull run phases.

   

• A rolling SIP (systematic investment plan) on the IT index has given annual CAGR returns of over 16% across 3 years, 5 year and 10 years. On a 10 year SIP of Nifty IT index, the probability of positive returns is 100% and the standard deviation is just 3%.

Clearly, the IT index ahs demonstrated a strong outperformance quality over the years.

NIPPON NIFTY IT INDEX FUND NFO – WHAT YOU MUST KNOW

Here are some key things to know about the Nippon Nifty IT index Fund NFO.

• Securities comprising the Nifty IT Index will comprise between 95% to 100% of the overall portfolio. The attempt will be to mirror the index passively with minimum tracking error.

   

• It offers exposure to the IT index in a passive manner. This eliminates unsystematic risk altogether since index funds are auto-diversified down to sectoral Beta.

   

• Being an index fund, the Nippon Nifty IT index totally eliminates the fund manager bias and the stock selection risk in fund management.

   

• Being an index fund, it does not require a demat account (unlike an index ETF). Also, this is not subjected to capital market volatility, the way an ETF is exposed.

   

• They are lower on the cost scale, due to the passive approach and, being an index fund, even SIPs are workable.

PERFORMANCE OF ACTIVE LARGE AND MID-CAP EQUITY FUNDS IN INDIA

Here is a quick look at the best performing large and mid-cap equity funds in India as of January 26, 2024. Returns beyond 1 year are CAGR returns.

PASSIVE FUNDS  (IT SECTOR)	NAV (Rs)	1-Year  (%) Returns	Benchmark  (1-Year)	Launch  Returns (%)	Launch Benchmark	Daily AUM  (Rs crore)
Aditya Birla Sun Life Nifty IT ETF	38.67	24.18	24.42	5.30	5.63	127.76
Axis NIFTY IT ETF	392.30	24.07	24.42	15.80	17.00	161.90
HDFC NIFTY IT ETF	379.88	24.10	24.42	21.60	21.92	63.15
ICICI Prudential Nifty IT ETF	39.48	24.20	24.42	24.94	25.35	440.99
ICICI Prudential Nifty IT Index Fund	12.58	23.26	24.42	16.97	17.56	366.40
Kotak Nifty IT ETF	39.30	24.23	24.42	16.43	17.68	115.41
Nippon India ETF Nifty IT	39.55	24.19	24.42	30.82	31.27	1,964.81
SBI Nifty IT ETF	394.76	24.12	24.42	20.20	20.27	126.95
Aditya Birla Sun Life Digital India	163.67	34.93	22.97	12.32	18.27	4,781.48
Franklin India Technology Fund	445.12	47.16	22.97	19.28	18.27	1,275.06
ICICI Prudential Technology Fund	179.69	28.93	22.97	12.83	18.27	12,372.84
SBI Technology Opportunities Fund	110.56	24.65	22.97	15.71	18.27	3,803.79
Tata Digital India Fund	43.47	32.32	24.42	19.88	18.27	9,702.09

Data Source: AMFI India

Since the IT index population is quite small we have included the passive IT funds and the active funds separately in the above list. The shaded portion pertains to the active IT funds while the non-shaded are the passive IT benchmarked funds and ETFs. Let us look at the active funds first. The active funds have a total AUM of Rs35,302 crore and account for bulk of the overall AUM of the IT funds in India. Let us look at the performance of active IT funds (shaded funds) in terms of average returns. Over a 1-year time frame, active IT funds have given average returns of 33.60%. However, this comes with a higher degree of variation. The maximum returns by an active IT fund in the last year was 47.16% and the minimum was 24.65%. If you consider active funds since inception, the average returns were 16% with the returns varying from 19.88% to 12.32%. Volatility in active funds is lower in the long run.

What about passive funds? The passive funds have a much smaller overall AUM of Rs3,367 crore and account for just 10% of the overall AUM of all IT funds in India. Let us look at the performance of passive IT funds (non-shaded funds) in terms of average returns. Over a 1-year time frame, passive IT funds have given average returns of 24.04%. However, this comes with a much lower degree of variation. The maximum returns by a passive IT fund in the last year was 24.23% and the minimum was 23.26%. If you consider passive funds since inception, the average returns were 19.01%. It should have been a lot better but for a single outlier. The moral of the story is that passive IT funds do add genuine value to investors.

GLANCE AT THE NIPPON INDIA NIFTY IT INDEX FUND NFO

Here are some details of the Nippon India Nifty IT Index Fund NFO you must know to decide on investing in the fund.

1. The NFO of Nippon India Nifty IT Index Fund opens for subscription on February 05, 2024 and the NFO subscription will close on February 16, 2024. Being an open ended fund, the fund house will offer purchase and redemption at NAV linked prices.

    

2. The Nippon India Nifty IT Index Fund NFO offers an opportunity to investors to participate in a diversified portfolio of large and mid-cap IT stocks. While the concentration will still be in IT stocks, it will combine the relative security of large cap IT stocks with the alpha potential of the mid-cap IT stocks.

    

3. Entry loads do not exist in India. In terms of exit loads, being an index fund, there is no exit load either. Investors are free to move in and move out at minimal cost. The STT will, however, continue to apply on sale. However, despite having no exit load, it is suggested to stay invested for a period of at least 5-7 years to get full index fund gains.

    

4. Let us turn to minimum investment in the NFO. Investors can put in applications for a minimum of Rs1,000 in the NFO and in multiple of ₹1 thereafter. Additional purchases on an ongoing basis can also be of minimum Rs1,000 and in multiples thereafter.

    

5. The fund offers Regular and Direct plans for the investors. In addition, investors can either choose the Growth option or the IDCW (income distribution cum capital withdrawal) option. Dividend plans offer payout and reinvestment options.

    

6. How will the fund performance be benchmarked? The Nipon Nifty IT Index Fund is already an index based fund, so question of outperformance does not arise. The focus of the fund would be to replicate the underlying index by reducing tracking error. The fund manager for the Nippon India Nifty IT Index Fund will be Himanshu Mange.

    

7. The investment objective of the fund is to seek long-term capital growth by replicating the Nifty IT Index and minimizing tracking error. However, returns are not assured. It is classified as a high risk fund. The Nippon Nifty IT Index Fund is exposed to all the systematic risks of the IT index and there is no guarantee of positive returns.

    

8. It will be classified as an equity fund for tax purposes. Dividends will be taxed at incremental rates in the hands of the investor. Short term capital gains (held for less than 1 year) will be taxed at 15% while long term capital gains (held for more than 1 year) will be taxed at 10% flat above the base exemption limit of Rs1 lakh.

The Nippon India Nifty IT Index Fund NFO is an opportunity for investors to participate in the long term growth and appreciation of the IT stocks through the passive approach. The passive focus also keeps the costs low.