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Tech funds: A mistake if you had invested
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August 13, 2007 09:13 IST
Last Updated: August 13, 2007 09:22 IST

In this article we discuss the performance of the infamous technology funds. With the benefit of hindsight, of course, they are infamous. But in the first quarter of 2000 they were a rage; and why not? The doubled your money in less than three months then!

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  • In the 1999 and early 2000 period, Technology-Media-Telecom (TMT) stocks were the stock market favourites. In case of technology and related companies, the view that outsourcing to India will grow rapidly (estimates ranged at times more than 100 per cent pa growth for many years to come) boosted sentiment to such levels that the valuations of these companies reached stratospheric levels.

    Then of course there was this hype about the internet and the services (hardware and software) adding to the mania. In those days any company that announced a venture/initiative which had an "e" as a prefix or "technology" as part of its name, saw its stock price sky rocket. Making money on the stock markets was easy; all you had to do was invest in companies from the TMT sectors.

    But as it always happens, rationality returned to the stock markets. The 'punters' realised that their estimates of growth (which were in any case a lot higher than what the well-managed companies expected!) are unachievable.

    In a lot of cases the realisation was that the companies never even pursued the businesses which their names seemed to suggest!

    Valuations of companies were marked down as overall sentiment took a beating and what you had was probably the worst bear market in recent history. Since our aim in this note is not to discuss the TMT meltdown, we will not delve into this much more.

    The point to note here is that you made a lot of money if you had timed your entry and exit in a tech fund to perfection; you could have probably doubled your money in three months.

    But in case you had erred, you lost a packet. And why that hurts is because if you had invested wisely, even at the height of the mania, you could still have made a very attractive return by simply remaining invested for a 5-Yr period in a well managed diversified equity fund.

    Just to put some numbers to this - your investment in a diversified fund like HDFC [Get Quote] Equity would have grown by 2.5x, while that in a tech fund would still be down 50 per cent!

    On a point to point basis, over these seven and a half years, an investment in HDFC Equity Fund has grown by 6.7x; the best performing tech fund on the other hand has grown to just 1.4x. The graph below illustrates this -

    Another point to note is that at all points in time there were opportunities in the TMT sector which were also attractive from a valuation perspective. However, there were not enough of them to justify an investment via a fund that had to invest all its monies in these sectors only.

    Such a fund took away the flexibility from the fund manager to "not invest" when he did not find attractive opportunities (a couple of funds of course were simply punting with the investors' money - we are not considering such funds here). He had to in other words remain invested as the whole stock price cycle went up and then came all the way down. In case of a well managed diversified equity fund, this flexibility was there, and they used it to their advantage.

    In this article we have been attempting to guide you, the investor, from not going overboard when it comes to investing in sector funds. We recommend that you avoid these funds; but invest if you must, then ensure that the exposure to such funds does not exceed 5-10 per cent of your portfolio.

    When making the allocation keep in mind that a well managed diversified equity fund will anyways own stocks from sectors that hold attractive prospects.

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