Most long-term investors should have at least some of their investments in technology stocks. After all, high tech is the engine behind the powerful U.S. economy and the bull market over the past decade. The downside: These stocks are exceptionally volatile. But their swoons create buying opportunities, and this summer has been no exception, according to many tech-fund managers.
If you're thinking of buying tech while it's down, a good way to do so while reducing the risk of owning individual stocks is to buy a high-tech mutual fund or a diversified equity fund with a big tech stake. Indeed, despite the recent pullback, specialized tech funds as a group have racked up a strong record. The 17 tech funds with five-year records tracked by Morningstar produced an average return, annualized through July 31, of 31%. That beat the Standard & Poor's 500-stock index by 4 percentage points. Last year, the overall tech group--numbering 50 funds--had an average 55% return, nearly double that of the S&P 500. Through July 31, they were up 40%, four times the S&P's return. The big numbers result in part from a handful of Internet funds with huge gains. Still, a well-chosen tech fund stands a good chance of raising your returns over the long haul.
The question is, which? There are huge variations in performance, and tech-fund strategies and risk profiles can differ radically. This year's top-performing tech fund through July 31 is Nicholas-Applegate Global Technology Fund, up 156%. The worst? Fidelity Select Software & Computer Services, up 11%. The former, a year-old fund designed for institutions and wealthy individuals who can afford its $250,000 minimum investment, profited from a timely switch this spring from Net stocks to a diverse group of telecom and chip issues. The Fidelity fund, by virtue of its narrow objective, had most of its assets stuck in a sluggish sector: software.
Performance numbers are not the entire picture, though. Before adding tech to your portfolio, you need to decide how much risk you're willing to take. Investment specialists suggest that before you take the plunge, you should check the technology weighting in your existing portfolio. "Chances are you've already got more than you think," says Morningstar associate editor Christine Benz. As tech stocks make up 21.2% of the S&P 500, you already have a pretty good stake in the sector if you're heavily invested in S&P index funds. Many diversified growth funds are also loaded with tech. Fidelity Magellan has 27% of its assets in technology, including telecom stocks that it labels "utilities." That might be enough technology, depending on your time horizon and stomach for losing money.
A quick way to assess a tech fund's risk level is by checking its volatility vis-a-vis the S&P. Its beta is a key statistic. A fund with a beta of 1 would be exactly as volatile as the market. Tech funds are more volatile. Morgan Stanley Dean Witter strategist Leah Modigliani calculates that the average tech fund with three years of results has a beta of 1.35--in other words, it's 35% more volatile than the S&P. Some funds are considerably more volatile: The WWW Internet Fund, for one, has a beta of 1.7. But don't use beta as your only guide. High betas often mean high returns, and low betas can pop up in concentrated funds.
Price-earnings ratios, on the other hand, may not necessarily be good risk indicators. Many funds own stocks in Net companies that have yet to post earnings, so stocks can be left uncounted in a fund's p-e ratio, resulting in a misleading indicator. WWW Internet Fund has the same p-e as the average tech fund: 49.
Investors also should bear in mind that tech funds are susceptible to high capital-gains distributions that can sharply reduce pretax returns unless the fund is held in a tax-deferred account. And shun funds with high loads. Remember, tech funds have higher-than-average expense ratios, usually because managers trade rapidly in and out of stocks. This shouldn't be a problem if the fund produces stellar returns.
OLD HANDS. Tech funds come in two basic flavors: broadly diversified ones that own companies across a wide swath of the landscape and highfliers that focus on narrow segments, such as the Net or small companies. In general, the narrower the focus, the riskier the fund, but the higher the potential short-term return. Funds with the best three-to-five-year records tend to be diversified.
Most tech funds fare poorly in BUSINESS WEEK's risk-rating system because we use tough criteria that exclude most of them from our rankings. Our rating system, which covers all kinds of mutual funds, includes only those with five years of results. Many tech funds, especially Net funds, haven't been around five years. Moreover, our system heavily penalizes funds that have wide downward swings--Standard for most tech funds. But in the rapidLy changing world of high tech, three years of results covers a broader range of tech funds and is sufficient to tell the winners from the dogs.
Indeed, BUSINESS WEEK's top-rated tech fund, Firsthand Technology Value, has the best five-year record of any U.S. mutual fund, with a 51.5% average annual return for the five years through July 31. It recently saw the departure of co-manager Ken Kam, who picked health-care stocks. But Kevin Landis, now the fund's sole manager, picked the bulkof its investments--mainly chip stocks--and says Kam's departure won't breed major changes.
Among divErsified tech funds, there are other good choices. Morningstar's top-performing funds with below average risk ratings over the past three years include Northern Technology (BW--July 5) and Dresdner RCM Global Technology, with three-year annualized returns of 53% and 50%, respectively. Northern Tech fund co-manager George Gilbert says he looks for "unique and durable franchises," and his fund typically holds about 100 stocks across a range of sectors. He attributes his big gains this year mainly to chip stocks such as Xilinx and STMicroelectronics. Dresdner RCM, meanwhile, has done well investing in Net, communications, and software stocks. Another fund to consider is Fidelity Select Technology. Its appeal is due partly to manager Andrew Kaplan, who has been one of Fidelity's hottest technology managers since 1995. He took over the fund early in 1998 and produced a 74% gain last year; he's up 34% through July 31 by taking big stakes in telecom stocks. Investors who want to gamble on big returns might also consider a fund run by managers with strong track records. A leader in this group is Amerindo Technology, up 98% through July 31, run by veteran tech investor Alberto Vilar.
Some diversified equity funds with heavy tech weightings can also give your portfolio a kick with less risk than a pure tech fund. Thomas Batterman, a financial planner in Wausau, Wis., likes White Oak Growth, a five-star Morningstar fund with more than half its assets in technology and average annual growth of 35% over the past five years. "I don't like to put all my assets into one sector," Batterman says, adding that White Oak typically rotates out of poorly performing industry sectors.
Another highly rated aggressive growth fund with heavy tech exposure is Janus Olympus. With 45% of its assets in tech, it boasts a 38% average return over the past three years. Manager Claire Young gets fast-growing companies where she finds them and owns Tiffany and Time Warner along with America Online and eBay. Olympus has a beta of 1.1, meaning it has achieved its gains with just a bit more volatility than the S&P. Whether you're interested in a pure play or a more diversified fund, it's not hard to spice up your poRtfolio by picking a performer with the high-tEch exposure you want.