Mutual funds are gradually rebuilding their exposure to technology stocks after months of caution, supported by easing concerns over artificial intelligence disruption, improving valuations and a strong recovery in Indian IT shares.

Technology mutual funds gained 13.87 percent in July after declining 6.40 percent in June. The Nifty IT index also rose 19 percent during the month, marking its strongest monthly gain in six years.

The improvement was reflected in mutual fund portfolio allocations. Technology recorded the largest month on month increase in sector weight among major sectors in July. Mutual fund exposure to IT increased to 6.6 percent from a record low of 5.9 percent in June, representing a 70 basis point increase. However, allocation remained below the 8 percent recorded in July 2025, indicating that fund managers are only beginning to rebuild their positions in the sector.

Technology allocation also remained below the 7.3 percent weight of the sector in the BSE 200. According to a Motilal Oswal report, Aditya Birla Sun Life Mutual Fund, Franklin Templeton Mutual Fund, PPFAS Mutual Fund, Sundaram Mutual Fund, Tata Mutual Fund and UTI Mutual Fund had technology allocations above the benchmark.

Stock level buying also increased during July. Mutual funds made net purchases of around Rs 306 crore in KPIT Technologies and Rs 289 crore in LTIMindtree. Other technology companies that saw increased mutual fund holdings included Sagility, Mastek and Tata Elxsi.

Fund managers, however, remain cautious about the sector's near term growth outlook. The transition towards AI led technology spending is expected to keep revenue growth and margins under pressure before the benefits of higher productivity and increased technology adoption become more visible.

Vaibhav Dusad, senior fund manager at ICICI Prudential AMC, expects IT sector growth to improve over the next three years, although margins could moderate from current levels. He views the current weakness as a transition phase rather than a structural deterioration in the sector.

Quantum Mutual Fund fund manager Christy Mathai also remains constructive on IT but highlighted revenue deflation as a key near term challenge. Pricing pressure is estimated at around 2 to 3 percent depending on the company and service line. Despite weak global discretionary spending, deal activity has remained resilient, which could support stronger growth if technology spending normalises.

Artificial intelligence remains a major factor shaping the sector outlook. Fund managers increasingly view AI as a transition in the economics of IT services rather than a structural threat to the industry. AI driven productivity improvements are currently creating pricing pressure as clients seek to capture efficiency benefits, but higher volumes could eventually offset some of the resulting deflation as enterprise adoption matures.

The outlook across market segments remains mixed. Dusad expects mid cap technology companies to continue delivering faster growth than large caps, while Quantum Mutual Fund remains more comfortable with larger IT companies because of their scale, capabilities and ability to participate in enterprise technology spending.

Quantum had remained slightly overweight IT during the correction and used weakness in February and March to increase holdings. IT currently has the highest allocation in the fund house's Value Fund and ELSS Fund, while exposure across other funds is closer to benchmark levels. However, the fund house is not aggressively increasing exposure at current valuations and is waiting for better opportunities.

Overall, the July recovery marks an early improvement in institutional sentiment towards Indian IT stocks. While mutual fund allocations have increased, positioning remains below both historical levels and the broader market benchmark, suggesting that fund managers are becoming more constructive but have yet to make a broad based return to the sector.