Tech Funds Suffer Broad Setback, but It’s Far Worse For Some
On second thought, maybe Internet-only mutual funds aren’t such a great idea.
The bear market that tore through the Nasdaq Stock Market from March through May left an ugly scar on tech funds of all sorts, with almost every one of the 70 funds tracked by Morningstar Inc. registering a loss for the quarter.
But funds that spread their bets throughout the tech sector--and in particular, that went light on shares of money-losing “dot-coms”--fared far better than their more specialized brethren.
Even with a second-quarter decline of 11.7%, the average tech fund still was up 5.2% for the first half, according to Morningstar.
And several funds with big exposure to semiconductor-related stocks, the quarter’s best-performing tech group, managed to hold on to some of the juicy gains rung up in the first quarter. Funds heavy in fiber-optic-related shares central to the development of broadband services have climbed sharply in the last month.
By contrast, every fund with Internet in its name is down for the year so far, several between 20% and 40%.
To be fair, Net-focused funds were superstars last year, when dot-coms were all the rage. The Munder Net Net fund, for example, rocketed 176% in 1999. In the second quarter of this year, it lost 19.3%.
Still, the second quarter shake-up points up the flip side of investing in the riskiest segments of an already volatile sector.
“Not having the latitude to move into the parts of the market that are working is an important disadvantage for the Net-focused funds, and we’re really seeing that for the first time,” said Christine Benz, a Morningstar senior analyst in Chicago.
The performance gap between broad-based tech funds and Net funds has been even more pronounced in the last month--as Nasdaq has staged a partial recovery--than it was during the decline.
For example, the Van Wagoner Technology fund, run by Garrett Van Wagoner and arguably the nerviest of all broad-based tech funds, lost half its value from early March to late May. But it has rebounded 54% since, for a net second-quarter loss of 3.1%.
Meanwhile, the Kinetics Internet fund, which was one of the first specialized Internet portfolios, also lost about half its value in the spring plunge. But it has recovered just 13% since, as dot-com stocks have remained out of favor. The fund’s second-quarter loss: 33.4%.
Though Net fund managers naturally defend their sector as simply suffering a bout of profit-taking after last year’s heady gains, the composition of many Net funds has changed; many fund managers now claim to eschew dot-com stocks, particularly the e-commerce names that are so widely disparaged.
“Unless you stick the evidence in their face, you’re not going to get any portfolio managers to admit they’ve got dot-coms,” Van Wagoner said.
Peter Doyle, co-manager of the Kinetics Internet fund, said his dot-com exposure is now 10% of the portfolio, down from a peak of 60%. He said he has only tiny pieces of such Net giants as Yahoo and CMGI.
Instead, he’s targeting a wider range companies that will benefit from the further development of the Net, he said.
“For people to expect to get triple-digit returns in a linear fashion is not realistic,” Doyle said. “That doesn’t mean that we’re not going to be a great investment for our shareholders going forward. If you want the excellent returns, it means you’re going to have to accept periods when your stocks are down.”
So far at least, it appears that most tech-fund shareholders are indeed accepting the spring losses as part of the game.
Record sums flowed into tech-dominated mutual funds in the first quarter--just in time for the market’s peak, reached in mid-March.
Yet many funds companies say there have been no dramatic outflows in recent months, even though most newcomers are under water.
The Firsthand tech fund group, for example, said it hasn’t had net redemptions in any week this year. Inflows totaled $1 billion in the first quarter, and the company took in about $450 million in the second quarter despite the tech sector’s meltdown.
By contrast, during the Russian financial crisis in late 1998, the fund had “serious redemptions” for a few weeks, said Steven Witt, Firsthand managing director.
“People have pretty much bought to hold and are willing to ride out these rough patches,” Morningstar’s Benz said.
Brian Hanson, manager of the Fidelity Select Electronics fund, which lost 3.6% in the second quarter but still was up 36.9% for the half, reasons that investors have hung tight because technology’s growth long-term prospects appear no less dim than they did at the start of the year.
“The sell-offs we see now are market-oriented, psychology-oriented,” he said. “It’s not a fundamental slowdown” in the business.
The relative lack of redemptions by tech-fund shareholders allowed many fund managers to stay in the market in the spring. Some managers boosted their cash holdings in the quarter, generally to between 5% and 10% of assets. But many say they chose not to time the market and instead stay fully invested.
Many managers used the sell-off to add to their holdings of favored stocks--which helped fuel the tech sector’s rebound starting in late May.
Van Wagoner, for example, bought back stocks such as e-commerce facilitator Ariba, wireless-telecom equipment maker Netro and Web content manager Interwoven after having unloaded them at much higher prices in March. He also redeployed some money into biotech shares after their deep sell-off; biotech has been among the hottest groups in the Nasdaq rebound of the last month.
Van Wagoner also has gone against the grain by taking a flier on a handful of small and as-yet unprofitable Net-related firms, such as Web site software firm Eprise. He said he’s looking for companies with promising business models--and with sufficient cash reserves to tide them over in a difficult financing environment.
Though some investors have come to believe that technology no longer is a cyclical business, many fund managers concede that the economy’s outlook is key to their expectations for tech stocks in the second half.
Demand for tech products remains very high, and the outlook for earnings growth in the sector is strong, fund managers say. “I haven’t seen this many bullish companies in a long time,” said Deborah Koch, co-manager of the Kemper Technology fund.
But if the economy slows too sharply, Wall Street could start sweating a profit squeeze at many tech firms, fund managers say.
Van Wagoner worries about the semiconductor sector. New chip production capacity that’s coming on line could relieve a lack of supply that has boosted chip pricing and the stocks, he said.
The general bearish argument against tech is that the stocks’ valuations remain in the stratosphere, even after the second-quarter declines.
Shares of networking giant Cisco Systems, for example, are down 23% from their 2000 peak. But at about $63 a share, Cisco still is priced at 119 times its expected earnings per share in the current fiscal year.
Valuations such as those leave little room for error, critics say.
Koch acknowledged the inherent optimism of most tech managers. “We’re genetically programmed to be bullish on tech,” she said.
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Walter Hamilton can be reached at walter.hamilton@latimes.com.
