In a surprising move, mutual funds have increased their allocation to the IT sector, despite significant declines in major IT stocks. This contrarian approach highlights a growing confidence among fund managers in the sector's potential for recovery and long-term growth.

Allocation Increase and Stock Performance

Mutual funds have raised their allocation to IT stocks to 7.9% in August, up from 7.8% in July. This increase comes against a backdrop of substantial declines in major IT companies:

• Tata Consultancy Services (TCS): Down 32% from peak
• HCL Technologies: Declined 27%
• Infosys: Fell 25%

Sector Ranking and Fund Flows

The IT sector now ranks third in mutual fund allocations, following:

1. Private Banks: 17.5%
2. Automobiles: 8.5%
3. IT: 7.9%

Infosys, in particular, has seen significant interest from mutual funds, receiving the largest inflow of Rs 5,000 crore. The company has also announced a substantial Rs 18,000 crore buyback, signaling confidence in its financial position and future prospects.

Attractive Dividend Yields

One factor drawing mutual funds to IT stocks is the attractive dividend yields they currently offer:

These yields provide a cushion for investors in a sector that has faced recent challenges.

Fund Managers' Perspective

Fund managers cite attractive valuations after a three-year downcycle as a primary reason for their contrarian approach. The significant stock price declines have created potential buying opportunities for those with a long-term investment horizon.

Challenges and Future Outlook

Despite the optimism from mutual funds, challenges remain for the IT sector:

• Jefferies warns that artificial intelligence (AI) may drive a 20% revenue deflation in IT services over the next five years.
• The research firm expects only 3.8% growth for the sector during this period.

These projections suggest that while there may be short-term opportunities, the long-term landscape of the IT services industry could face significant disruption.

Conclusion

The increased allocation to IT stocks by mutual funds, despite recent market performance, reflects a complex interplay of factors. While attractive valuations and dividend yields are drawing investors, the potential impact of AI on the sector's future revenue streams cannot be ignored. As the industry continues to evolve, investors and fund managers will need to carefully balance short-term opportunities with long-term technological trends shaping the IT services landscape.

Infosys, the Indian IT giant, saw its shares decline by 1.6% to Rs 1,501.40 on Monday, as investors moved to book profits following last week's substantial rally in IT stocks. This pullback comes in the wake of Infosys' announcement of its largest-ever share buyback program, which had previously fueled a sector-wide surge.

IT Sector Retreat

The broader IT sector also felt the impact of the profit-taking sentiment:

• The Nifty IT index fell by 1%, emerging as the primary drag on benchmark indices.
• Other major IT players experienced declines:
  • Tata Consultancy Services (TCS) dropped 1%
  • Persistent Systems, HCL Technologies, Coforge, Tech Mahindra, and Wipro saw declines ranging from 0.7% to 1%

This sector-wide retreat follows a robust 4.3% rally in IT stocks last week, highlighting the volatile nature of market sentiment.

Infosys Buyback Program

The recent rally was primarily driven by Infosys' announcement on September 12 of a record-breaking share repurchase program:

This ambitious buyback plan aligns with Infosys' strategy to return 85% of free cash flow to shareholders over the fiscal years 2025 to 2029.

Market Impact

The announcement had a significant impact on Infosys' market valuation:

• Last week's gains added Rs 33,736.83 crore to Infosys' market capitalization
• The company's total market cap reached Rs 6.33 lakh crore

Market Outlook

While the IT sector faces a short-term pullback, market participants are also turning their attention to broader economic factors:

• Increased caution ahead of the U.S. Federal Reserve's upcoming policy meeting
• Investors are likely to closely monitor global cues and their potential impact on the IT sector, which derives a significant portion of its revenue from international markets

As the market digests the recent buyback news and awaits further economic indicators, the IT sector may continue to experience some volatility in the near term.