Amongst many NFO launches in 2021, international investing was a hot theme. Given the outsized stock returns from US big tech companies in recent years, NFOs focused on the tech-heavy Nasdaq-100 index were in vogue, with 3 of the NFOs this year being Nasdaq-100 Fund of Funds (FoFs).

There are now 5 passive funds that track Nasdaq-100 — two (Motilal Oswal Nasdaq-100 ETF & FoF) have more than 1-year track record while Kotak Nasdaq-100 FoF has about 10 months’ operating history. Two funds, ABSL Nasdaq-100 FoF and ICICI Pru Nasdaq-100 Index Fund, were launched recently.

The case for investing

Investors often invest in Nasdaq-100 funds because Indian tech-focussed funds as of now do not offer much access to unique business models and advanced technologies. Given the fact that the US has largely remained the cradle of innovation as far as tech themes are concerned, with hardly any strong competition from companies in the rest of the world, Nasdaq-100 remains one of the best ways to play the theme in the current decade, for now. Some of the winners of the last decade forming part of the Nasdaq-100 currently are Apple, Microsoft, Amazon, Tesla and Alphabet (top 5 stocks).

Many other companies in the index are already at advanced stages of developing and commercialising emerging themes for this decade — like Tesla in the field of autonomous cars, Alphabet in IoT and Facebook in metaverse. The index also includes companies that will indirectly benefit from these themes, like semiconductor companies Advanced Micro Devices, Micron, Qualcomm and Nvidia whose chip design technologies are bare essentials to making technology work.

The index has over 50 per cent exposure to information technology and around 20 per cent exposure to consumer discretionary.

How have the funds fared?

A review of the performance of Nasdaq-100 focused funds shows that they have not disappointed.

The Nasdaq-100 per se has gained 27 per cent this year vs the 29 per cent gain for the broader S&P 500 index of the US, and 24 per cent and 30 per cent for the Indian bellwethers Nifty 50 and Nifty 500 respectively . Passive funds from Motilal Oswal as well as Kotak show negligible tracking difference, adjusting for currency depreciation.

Given the inherent tech-stock growth and multiple expansion, funds focused on the Nasdaq-100 funds, on an average, have outperformed other US-focused funds by 700 basis points (bps) in 6 months, and 800 bps over a 1-year period. The alpha in favour of Nasdaq-100 funds holds if you extend the performance study period to 3 and 5 years too.

From an expense ratio perspective, Motilal Oswal Nasdaq-100 ETF & FoF cost 50-57 basis points while the more recent launches (and smaller-sized ones) have higher costs i.e. Kotak Nasdaq-100 FoF (67 bps) and ICICI Pru Nasdaq-100 Index Fund (100 bps), according to Value Research data. These compare favourably with other US-focussed funds, some of whom have expense ratios of more than 200 bps.

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Wait for better entry points

While the case for investing into the passive funds tracking Nasdaq-100 is good, investors must wait for correction in Nasdaq-100 before making lumpsum investments. The index now trades at a trailing price to earnings ratio of 30 times — a 25 per cent premium to its 10-year average valuation, and 7 per cent premium to its 5-year average. While this may not appear a like high premium it needs to be noted that the index earnings is getting a huge one time bump of around 55 per cent growth in earnings in CY21. This is driven by one off factors and makes PE appear not too expensive. The expected growth in earnings for CY22 over CY21 is modest at just around 9 per cent (Bloomberg). This is less than half the last 5 years’ earnings CAGR of 20 per cent.

The heightened valuations in the backdrop of decelerating earnings growth in CY22 is accentuated by the downside arising from the impact of the Federal Reserve winding up its tapering and likely raising interest rates multiple times in CY22.

From a long-term investing perspective to play the new themes that will re-ignite earnings growth acceleration as they gain mass adoption, anywhere between 20 and 25 times trailing PE would be a good starting point. Based on CY21 expected earnings, that would imply a correction of at least 25 per cent in the Nasdaq-100 index from current levels, sometime in CY22.

(With inputs from Kumar Shankar Roy )