Cash Avalanche Suddenly Swamps Tech Stock Funds

Technology stocks have been leading the bull market for most of the 1990s. But technology-sector mutual funds, despite strong performance numbers all decade long, have attracted only modest attention--and modest cash inflows--from the small investor.

Until now.

Through the first 10 months of 1999, Americans plowed more new money into tech-sector stock funds--$17 billion--than they did in the previous 10 years combined, according to fund tracker Strategic Insight in New York.

By contrast, the 1998 net cash inflow into tech-sector funds was a mere $600 million.

The avalanche of cash this year into tech mutual funds provides at least a partial answer to the question: Who’s been bidding up tech stocks lately? Tech fund assets in total now stand at about $71 billion, up from $33 billion at the start of the year.

But the surge in money inflows also is setting off alarm bells among some analysts, who fear it could be indicative of a peak in the tech-stock mania--at least, if history is a guide.

To be sure, the tech-fund sector, led by such giants as T. Rowe Price Science & Technology, Fidelity Select Electronics and Alliance Technology, still is small overall: It holds less than 2% of total stock fund assets.

But investors have become so enamored of the funds that, in one November week, the tech sector attracted $2 out of every $3 that went into equity mutual funds.

Performance, obviously, is what’s driving this: The average tech-sector fund has gained 112% thus far this year, compared with 19% for the average diversified stock fund.

But the tech funds’ performance was spectacular in 1998 as well--when the average fund in the sector rose 51%--yet the sector’s inflows were nothing compared with this year’s.

Which has Christine Benz, a tech fund analyst with fund tracker Morningstar Inc., wondering: Are many fund investors, perhaps fearing that they missed the ‘90s tech rally, trying to make up for it all at once as the decade comes to a close? “That’s certainly a possibility,” Benz says.

And if so, are they too late?

Many analysts have prematurely laid the bull market to rest in recent years, of course. Still, Alan Skrainka, chief market strategist for St. Louis-based brokerage Edward Jones, notes that cash flows into sector funds “can be an incredibly reliable indicator of market and sector peaks.”

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Case in point: A decade ago, investors thought Japan stock funds were a “sure thing,” notes Greg Schultz, principal with Asset Allocation Advisors, a money management firm in Walnut Creek, Calif. In the 10-year period ended December 1989, the average Japan fund delivered average gains of 22.6% a year, according to fund tracker Lipper Inc.

Between the end of 1987 and the end of 1989, assets in Japan funds available to U.S. investors nearly doubled, as cash poured in. That was just in time for the Japanese market’s peak, reached Dec. 29, 1989. In the decade that followed, the average Japan fund lost approximately 5% a year.

In the early ‘90s, it was biotechnology’s turn. From 1989 through 1991, the Fidelity Select Biotechnology fund posted annual total returns of 44%, 44% and 99%, respectively--pasting the Standard & Poor’s 500 index of blue-chip stocks. Yet it took most investors until the third year of that three-year rally to muster the courage to invest in the biotech fund sector, notes Sheldon Jacobs, editor of the No-Load Fund Investor newsletter in Irvington-on-Hudson, N.Y.

At the start of 1991, Fidelity Select Biotechnology’s assets stood at $224 million. By the end of that year the fund had ballooned to $1.1 billion. Shortly thereafter the biotech boom went bust. The following year, the fund lost nearly 11%.

More recently, at the end of 1998, investors who finally piled into hot Europe stock funds got whipsawed as much of the region slid into recession.

“History has a weird way of repeating itself,” Schultz says. “They just change the names.”

In light of the recent torrent of cash flowing into tech funds--and the growing volatility in the sector (for instance, shares of Internet portal Yahoo soared $67 a share in a single day last week)--Edward Jones’ Skrainka says he has become much more cautious about tech stocks.

“Tech has a very bright, long-term future,” he says. “But in the investment world, price ultimately matters. I think Cadillacs are great automobiles, but I’m not paying $5 million for one--which is what investors are doing with tech.”

Mutual fund analysts say individual investors ought to take a similarly cautious approach when it comes to tech funds now.

For one thing, as the Japan and biotech sector experiences show, “Investor timing has been really abysmal,” notes Morningstar’s Benz.

For another, even if tech continues to shine, which is certainly a possibility, some tech funds may not. History has shown that hot funds often cool down when they receive so much money so quickly that they have difficulty putting it all to work in the market.

This is one reason Garrett Van Wagoner recently closed two of his red-hot technology-oriented funds--Van Wagoner Emerging Growth and Van Wagoner Micro-Cap--to new investors.

Already, there are more signs that tech fund managers are having difficulty investing all this new money. For instance, the average tech fund recently held 7.3% of its assets in cash. That’s 46% more cash than the average domestic stock fund held.

More than a quarter of all tech funds recently held at least a 10% cash position. Some, including First Hand Technology Innovators, Van Wagoner Technology, Fidelity Select Technology and Orbitex Info-Tech & Communications, held substantially more.

To be sure, it’s hard not to want to load up on tech at a time when these stocks are so thoroughly dominating the market.

On a compounded basis, tech funds have made, on average, three times more money in the ‘90s than the typical U.S. diversified stock fund. Not only have tech funds been the hands-down best-performing category of funds over the last one, three, five, 10 and 15 years, they appear to be gaining, not losing, steam. In the first three quarters of the year, 11 stocks accounted for 100% of the performance of the S&P; 500, according to Leah Modigliani, a U.S. equity analyst for Morgan Stanley Dean Witter in New York. Eight of those 11 were tech stocks--led by Microsoft, Cisco Systems, IBM, Intel and Sun Microsystems.

Some tech aficionados argue that tech, unlike other sectors, will continue to outperform the market because it is a necessary component of most every industry.

“They might be right,” Schultz says. “But only a fool will dismiss the possibility that they may be wrong.”

For investors who won’t need to tap their investments for at least another 10 years, having a decent amount of exposure to tech is still a good idea, analysts say. “It will continue to be America’s fastest-growing sector,” Skrainka says.

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But before you seek this exposure through a sector fund, check to see how much technology you already own through your diversified stock funds. You may already have a substantial tech stake.

For instance, technology companies now comprise more than 25% of the S&P; 500, up from 8% a decade ago. So if all you own is an S&P; 500 index fund, $1 out of every $4 you have in the market is already invested in tech companies.

To do at least as well as the indexes, active managers have had to stock up on tech. More than 30% of all large-cap growth fund assets, for instance, are currently in tech. And nearly 40% of the assets invested in all growth-oriented funds are tied up in tech. “I don’t think the average investor realizes the extent to which tech is already in their diversified funds,” Jacobs says.

Also, bear in mind that most tech funds are relatively new. According to Morningstar, only about half of the 100 tech funds in existence have a three-year track record (many experts advise investors not to buy a fund that’s less than 3 years old). Only a quarter have been around for five years or more.

What’s more, only nine tech fund managers have been with their funds for more than three years. “A lot of these managers are rookies,” Schultz says.

That’s why Schultz, Jacobs and others think investors, especially those with time horizons of less than 10 years, might want to consider a diversified growth fund with a greater-than-average tech weighting rather than a pure tech fund if you’re buying today. A diversified fund would at least have the ability to cut its tech exposure if the sector were to turn down dramatically.

In the meantime, if the sector does turn down, even momentarily, that may create some buying opportunities for longer-term investors who want a tech fund--just not at today’s prices.

“There’s a tendency among mutual fund investors to jump in when something’s got a great three-year or five-year track record,” Jacobs says. “Which may be fine when it comes to a diversified fund. But it’s especially risky in a sector fund.”

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Do you have ideas for mutual fund and 401(k) topics for this column? Times staff writer Paul J. Lim can be reached at paul.lim@latimes.com.