Most technology investors live in mortal fear of a sharp drop in the Nasdaq. Not Paul McEntire. Last year, the rocket scientist turned hedge-fund manager opened the Marketocracy Technology Plus Fund, which mixes long positions on tech stocks with short sales of stocks he thinks will fall. The strategy took advantage of the rapidly falling, then rising, fortunes of tech stocks in 2001. His fledgling $1 million fund emerged as one of the top-performing tech funds tracked by Morningstar, down 4%--compared with a 38% decline for the average tech fund. Through Mar. 15 this year, he's up 3.4%.
A tech fund that can go both ways--long and short--has obvious advantages in a market that is ruthlessly sorting out the winners from the losers. In a period when most tech funds have done poorly, McEntire's ability to go short helped him avoid the crash.
McEntire is no big risk-taker. His strategy is to balance long-term bets on about 20 companies he likes with short positions in 8 to 10 companies he doesn't like. "The advantage of short-selling is that you can reduce risk and boost returns over time, assuming you do it with reasonably good stock-picking," he says. Indeed, his short holdings were key to his returns. He estimates that in the first 200 trading days of his fund, the Nasdaq was up half the time--and on its up days, his fund underperformed the index by 0.4%, while on down days the fund outperformed by 0.6%.
A handful of other mutual funds go both long and short. But hedged funds that focus exclusively on tech are usually accessible only to wealthy investors with $1 million or more. McEntire's mutual fund requires a minimum investment of $10,000. (Symbol: TPFQX; 888 884-8482). Still, his approach doesn't come cheap. His fund's annual expense ratio of 1.95% is much higher than the 1.44% average for U.S. equity funds.
McEntire, 57, relies in part on his engineering background to help pick stocks. He worked on the Apollo manned space program early in his career, then studied hedging strategies while earning a PhD in engineering economics from Stanford University. Despite his quantitative background, he says his stock-picking strategy is based on a combination of Warren Buffett-style value investing and his own assessment of a company's technology.
While the U.S. economy is picking up, McEntire is still wary of the tech sector. The 100 largest stocks in the tech-heavy Nasdaq still don't collectively earn a profit, he figures. As a result "most are priced based on hope, not on their performance." In fact, he worries that the Nasdaq will be "soft" for the next five to ten years.
That's why 35% of the fund is short positions on large tech stocks (table). His largest short is wireless carrier Nextel Communications (NXTL), now at $6.29. McEntire thinks it could go to zero. His reasoning: With $14 billion in debt and negative cash flow, he argues it lacks the resources to upgrade its technology. Other shorts include Amazon.com (AMZN) and Priceline.com (PCLN). He says Amazon hasn't proved it can produce sustainable profits. And Priceline is competing against the airlines' own efforts to sell their excess seats online.
The long positions are smaller, lesser-known names. His top holding is Kronos (KRON), a former factory time-clock maker now selling staff-management software over the Internet. Kronos defied the tech slump by generating higher sales and profits last year, and the stock has nearly tripled from its 12-month low.
A long-short fund is by no means a layup. The manager needs to be right on both sides. McEntire has made the strategy work. A diversified hedge fund he has run since 2000, called Skye, was up 27% in 2000 and 2001, while the Standard & Poor's 500-stock index fell 21.9%. Even when tech stocks as a whole do well, some will always falter. A strategy that can capitalize on both trends makes a whole lot of sense. By Geoffrey Smith