Can it get any worse? Tech funds are down 42.8% for the year through the end of August.
Too short a view? Fine. Tech funds for a one-year period through the end of August have lost 42.3%. Go out three years? It's still terrible. Indeed, tech investing now seems to be exhibiting all the signs of a sector in a state of long-term permanent decline.
Tech funds going back to the end of August 1999 were down 26.5%. How about five years, which would include some of the 1990s salad days for tech funds? Even for the five-year period that ended this past August, tech funds were still down -4.8% annually, according to Lipper Inc.
"I'm surprised anyone is even talking about them anymore," said Harold Evensky, a planner in Coral Gables, Fla., who won't use tech-sector funds. Evensky, who believes equity returns are going through a long-term decline, says he prefers to use index funds because costs become critical in bear markets.
"My recommendation on these tech funds is very simple: Sell them," said Edwin Morrow, a financial planner in Middletown, Ohio. Morrow argues that managers of these funds have not made the case that they are superior to a tech-investment expert simply picking one to two stocks for a client. "There's certainly a case for tech investment, but not in these funds," Morrow adds.
Fund observers and analysts are equally pessimistic. "I haven't seen a whole lot of optimism out of portfolio managers about where, how and when this thing turns around," says Chris Traulsen, technology fund analyst for Morningstar.
He argues that the funds that are able to survive in this brutal environment are those that have diversified across at least five or six tech sub-sectors or that have the leeway in their fund charter to hold significant amounts of cash. Too many tech funds and tech-heavy growth funds, Traulsen says, have loaded up on semiconductors and stayed fully invested, despite the worst of the tech crash.
"It's a familiar pattern. Too much concentration in just a few names, and sometimes even putting money in names no one has heard of," notes Don Cassidy, an analyst with Lipper. Tech funds, or growth funds that are closet tech funds, were always too risky, another fad that imploded, Cassidy says. He listed several examples of funds that had used these risky strategies
"My advice for planners and investors is you had better be sure that you aren't overloaded on these sector funds or that you don't have a fund that is still overweighted with tech," Traulsen adds. That's because there is still little evidence that America's corporations, in the midst of a sluggish economy that has eroded profit margins, will ramp-up technology spending any time soon.
"We're business momentum investors, and we're finding opportunities few and far between," says Mike Sutton, chief investment officer with Pilgrim Baxter. The fact that even some of the biggest tech bulls of the 1990s are so gloomy underscores how pervasive the pessimism is.
PBHG's Tech and Communications Fund has been badly beaten up over the last three years. After an incredible 1999, when the fund returned 243%, PBHG Tech and Communications lost 43.6% in 2000 and 52.3% last year. So far this year it hasn't been much better. The fund was down some 51% for the one-year period through August 31.
PBHG officials recently decided to have multiple managers run tech funds. It will also use various subsectors and different styles of investing on a fund as a way of limiting risks. Nevertheless, PBHG's Sutton concedes that some tech funds have been too concentrated. And many of his colleagues say problems remain for this investment style.
"There's still lots of work to do on the down side. Corporations are still worrying," adds Peter Trap, portfolio manager for Needham Growth Fund, a tech-heavy fund that was down 25.5% for a one-year period through the end of August and was actually slightly up for the three-year period.
Needham, which had 80% weighting in tech several years ago but has reduced it to 40% recently, has taken a more diversified approach. Trap has his share of tech losers-such as Computer Associates International and Lucent Technologies-but no position has been more than 2% in the portfolio. This diversification among techs companies, combined with the ability to sell short, has given Needham an outstanding record compared with many of his peers. Needham was actually up some 12.1% last year, a disastrous year for both tech and growth funds.
Nevertheless, Trap says that the market can and likely will be worse for tech funds before there is any improvement. For some funds, the improvement can't begin soon enough. For instance, Van Wagoner Technology, just a few years ago a popular tech fund with $400 million in assets when it began operations in 1997, was down some 62% through the first eight months of the year. It recently had just over 50% of its portfolio in software and about 20% of the fund was in three companies that were disastrous: Interwoven, Veritas Software and Embarcadero Tech.
Each of these positions was recently down between 62% and 77%. That's why this year seems to be a repeat of last year for the embattled fund. Last year Van Wagoner Technology lost 61.9%. In October, Van Wagoner was down to $32 million in assets, according to Morningstar.
Even when there is a tech turnaround, market observers say, it is unlikely that there will ever be a repeat of the heady days of the late 1990s. A series of simultaneous one-time events, including the PC revolution, the initial build-out of the Internet, and Y2K, created a business environment that was not sustainable. The late 1990s saw tech funds routinely racking up triple-digit returns. Funds such as Turner Technology, which began in the last half of 1999, gained 158%.
Now, outstanding returns in this sector are relative. Take the small Huntington Fund. The fund, with some $17 million in assets, was down only 10.1% for the year through the end of August, which is more than 30% better than the category and considerably better than the S&P 500. The latter was down some 20% in the same period. Still, some more upbeat managers say tech will turn along with the rest of the economy as it recovers from the threats of terrorism and the potential for runaway inflation that comes from war or the possibility of war.
"The better companies are starting to be in a position to provide earnings surprises," says Robert Turner, manager of the Turner Technology Fund, which was down 49.9% for the one-year period through the end of August.
Turner agrees that some tech funds were bound to fail at the first sign of trouble. That's because they made too many big bets on too few stocks in too few sectors, he says. And, although his relatively small tech fund has not been spared the pain, (down 26.8% annually over a three-year period), he still believes his diversified strategy is going to pay off as soon as the economy comes back.
Turner keeps the fund in at least six sectors and tries a little more diversity by tapping some consumer technology themes such as eBay and Electronic Arts. He also has what he calls a quality approach: buying tech companies such as Cisco Systems, Texas Instruments and Microsoft.
"Some of these companies have had low earnings expectations. It is likely that they are going to surprise the market," Turner claims. He also believes that both corporations and individuals have been spooked by the recession.
Some tech fund managers also contend that there are long-term tech companies that are steady enough to make it through this period and lead the way to the next bull market. "I believe that Cisco Systems, for example, is going to make its earnings estimates because of its cost controls," says Barry Raeburn, an analyst with PBHG. Two more examples of companies that Raeburn says are positioned to tough it out are Dell and Microsoft.
"Many individuals know their computer isn't up to speed and it needs to be upgraded, and a lot of corporations have been putting off technology upgrades. Once they start to feel better about the economy, many of these companies are going to come back," Turner predicts.
But plenty of skeptics think the tech bulls are simply in denial. "What do you expect them to say? Yes, that's the kind of story I'd be telling too if I was a manager in these kinds of funds today," Evensky says.
"I guess if you know that the market made a bottom in July and is now poised for a turnaround, then you might have reason to believe that these funds are about to make a comeback," adds Cassidy of Lipper. "But still, you really have to wonder."
In the meantime, Turner and other managers who have tech heavy investments know many of their investors have become impatient. Turner also has done something unusual in an industry that-until recently-was famous for its gluttony. He's cut his expense ratio as he's lost assets. The fund's expense ratio was recently 121 basis points. That's 14 basis points fewer than in the previous year and well below the industry average of 150 basis points. So far Turner's strategies haven't worked. Assets have dropped from $76 million to $18 million, and his fund has been outperformed by most of its peers over the last two years.
Needham Growth, by the way, had a high expense ratio at 187 basis points last year. Still, it had cut its expense ratio by 32 points from the previous year.
Even these shareholder-friendly moves prompt skeptics to question the motivation. "When they were accumulating assets, they couldn't cut expense ratios. Now that they're losing assets, they say they can cut expenses," Evensky wonders.
Even though they heard complaints from clients who wanted to know why they were missing out on triple-digit returns, some advisors were smart enough to put few or none of their clients' assets in these vehicles back in the late 1990s. It's no surprise, then, that advisors now are approaching these investments with apprehension.