Tech Funds: Worth The Investment Risk?

Technology funds have been a hot topic for investors over the past decade, with the technology sector enjoying stratospheric performance. Technology portfolios buy high-tech businesses, mostly concentrating on computer, semiconductor, software, networking, and internet stocks. Some also buy medical-device and biotechnology stocks, while others concentrate on a single technology industry.

Tech stocks remain popular, with investors drawn to the innovative nature of the sector. Information technology stocks currently represent the largest sector of the benchmark S&P 500 Index, comprising nearly 32% of the index's value.

So, should you invest in tech funds? Well, that depends on your risk appetite and investment goals. Tech funds carry higher risks than index funds, and investors need to be selective in their approach due to the potential for short-term volatility. However, tech funds have the potential for high growth and huge margins, making them attractive investment opportunities.

Tech funds vs. broader index funds

Tech funds and broader index funds are both investment options, but they differ in their level of diversification and risk. Tech funds focus on technology-related stocks, while broader index funds provide exposure to a wider range of industries and sectors. Here is a comparison between the two:

Tech Funds

Technology portfolios invest in high-tech businesses, usually concentrating on computer, semiconductor, software, networking, and internet stocks. Some tech funds also invest in medical devices, biotechnology, or a specific technology industry. Tech funds have been popular due to the innovative and dynamic nature of the tech sector. The tech sector's growth has been driven by emerging technologies such as artificial intelligence (AI) and cloud computing.

Tech funds can be volatile, and they are not suitable for investors who need quick liquidity or are risk-averse. While tech funds can provide high returns during favourable market conditions, they can also experience sharp declines when the tech sector underperforms, as seen in 2022.

Some examples of tech funds include:

• Fidelity Advisor® Semiconductors Fund
• Vanguard Information Technology ETF (VGT)
• MicroSectors FANG+ ETN
• First Trust NASDAQ Cybersecurity ETF
• IShares Semiconductor ETF (SOXX)

Broader Index Funds

Index funds are investment funds that aim to replicate the performance of a preset basket of stocks or a specific market index, such as the S&P 500 or the Nasdaq-100. These funds are typically well-diversified and offer lower risk compared to tech funds. Index funds are popular among investors because they provide immediate diversification, attractive long-term returns, and lower fees.

Broad index funds, such as those tracking the S&P 500, offer exposure to a wide range of companies across different sectors and industries. On the other hand, broader index funds like the Nasdaq-100 have a large weighting in technology shares but also include companies from other sectors.

Some examples of broader index funds include:

• Vanguard S&P 500 ETF (VOO)
• SPDR S&P 500 ETF Trust (SPY)
• IShares Core S&P 500 ETF (IVV)
• Invesco QQQ Trust ETF (QQQ)
• Vanguard Russell 2000 ETF (VTWO)

Tech funds and broader index funds each have their advantages and considerations. Tech funds offer focused exposure to the technology sector, which can be attractive during periods of strong performance. However, they carry higher risk and are susceptible to sharp declines when the tech sector underperforms. Broader index funds, on the other hand, provide diversification across various sectors and industries, offering more stable and consistent returns over the long term. When deciding between the two, investors should consider their risk tolerance, investment goals, and the overall market conditions.

Tech funds for Indian investors

Tech funds have long been attractive to investors due to the innovative nature of the industry. Technology stocks have outperformed the broader stock market in four of the previous five years, with 2022 being the exception.

When considering whether to invest in tech funds, it is important to remember that they are high-risk investments. Tech funds are a type of sector fund, which means they invest in stocks of companies operating in a single sector. This lack of diversification means that if the sector experiences a downturn, the stocks in the portfolio will also decline, with nothing to cushion the blow. Therefore, tech funds are only suitable for experienced investors, and even then, they should not make up more than 10% of your portfolio.

If you are an Indian investor considering investing in tech funds, there are several things you should keep in mind. Firstly, India's IT sector has been a key driver of the country's economy, and it is one of the world's most popular outsourcing destinations. The government's push for 'Digital India' and the growing demand for new-age technology have significantly benefited tech companies. As a result, technology mutual funds in India have consistently provided annualised returns of 15-19% over a five-year period.

• Franklin India Technology Fund
• ICICI Prudential Technology Fund
• SBI Technology Opportunities Fund
• TATA Digital India Fund
• Aditya Birla Sun Life Digital India Fund
• Edelweiss Technology Fund
• HDFC Technology Fund
• Invesco India Technology Fund
• Kotak Technology Fund

When deciding whether to invest in tech funds, Indian investors should consider their risk tolerance, investment horizon, and knowledge of the technology sector. While tech funds can provide attractive returns, they are volatile and carry high risks. It is recommended that investors closely monitor the performance of the funds and have a long-term investment horizon.

Tech funds' performance in 2024

The technology sector has had a strong year so far, with tech stocks rebounding after a poor performance in 2022. This has been driven by a shifting macroeconomic environment, as well as advancements in artificial intelligence (AI) and generative AI, which have renewed investor enthusiasm for the sector.

Tech funds have performed well in 2024, with the Technology Select Sector SPDR ETF (XLK) outperforming the S&P 500's total return in the past five years. Tech funds such as the iShares Cybersecurity and Tech ETF (IHAK), VanEck Semiconductor ETF (SMH), and iShares U.S. Tech Breakthrough Multisector ETF (TECB) are also considered good options for investors. These funds offer diversified exposure to the technology sector and innovative companies, including those in cybersecurity, semiconductors, and breakthrough technologies like robotics and AI.

Looking ahead, the technology sector is expected to continue growing and innovating, with AI playing a transformative role. However, it is important to note that not all tech companies or funds will succeed, and market uncertainty and elevated interest rates remain headwinds for tech earnings. As always, investors should conduct thorough research before making any investment decisions.

Tech funds' performance in the long term

Tech funds have been shown to perform well in the long term. In four out of the past five years, technology stocks outperformed the broader stock market. The only exception was 2022. In 2024, tech stocks are again outperforming the broader market, although their advantage has narrowed as market leadership has broadened to other sectors.

Tech stocks have been popular with investors due to the innovative nature of the tech sector. The chief equity strategist with U.S. Bank Asset Management, Terry Sandven, notes that "fast is getting faster, and speed, scale and efficiencies across the board don’t happen without technology."

Tech stocks are also attractive because of their potential for growth. Many investors view them as opportunities to invest in cutting-edge technology, which can be rewarding if a company's product or service takes off.

However, it is important to note that tech stocks can be volatile. Data breaches, competition, and economic trends such as interest rate hikes can affect their performance. Additionally, the tech sector contains a higher concentration of less-established companies that might not have turned a profit yet, making it challenging to assess the risks of investing.

When considering the long-term performance of tech funds, it is essential to carefully evaluate individual stocks or funds, diversify holdings, and consult with a financial professional to ensure that investment decisions align with your goals and risk tolerance.

Tech funds' volatility

Tech funds have been one of the best places to invest in over the past decade. The Nasdaq 100 index, a proxy for technology shares, has increased in value by 630% over the past 10 years, driven by the rise of artificial intelligence (AI), cloud computing, and social media. However, this strong performance has been accompanied by significant volatility.

Tech stocks experienced a significant correction in 2022 as inflation and interest rates rose, with the tech-heavy MSCI All-Country World Index returning -4.5% year to date as of February 16, 2022, weighed down by the tech sector's 9.4% slide. This volatility was the result of valuation adjustments as equity markets recalibrated for an era of higher interest rates.

Tech stocks are subject to short-term volatility due to various factors, including interest rate changes, regulatory and antitrust concerns, and the unpredictable nature of the industry. For example, chipmaker Nvidia's shares lost nearly two-thirds of their value from November 2021 to October 2022 before rising nearly seven-fold. The Nasdaq 100 has also experienced regular drops of more than a third and several bear-market drops of over 20% in the past 20 years.

When considering tech funds, it is essential to assess the skill of the fund manager in navigating market swings. Tools such as volatility, the Sharpe ratio, and max drawdown can help evaluate risk-adjusted returns. Some of the least volatile tech funds include the SPDR MSCI Europe Communication Services UCITS ETF and the Fidelity Global Technology fund.

While tech funds offer high upside potential, investors should carefully consider their risk tolerance and conduct thorough research before investing.

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