Twelve years after the tech wreck, technology stocks and the ETFs that follow them are trouncing the market. In the first three months of 2012 alone, the Technology Select Sector SPDR (XLK) rose 18.9%, while the SPDR S&P 500 ETF fund (SPY) rose 12.6%.

Retail investors aren't the only ones piling in. A global money manager survey from Bank of America Merrill Lynch reports that overweighting by U.S. fund managers is higher for technology stocks than it is for any other sector.

For financial advisors, the 42 technology-focused exchange-traded funds tracked by Standard & Poor's make it a lot easier to tilt the scales toward technology stocks than it was when the group was burning rubber in the late 1990s. While there is certainly room for debate about whether that's a good idea, these ETFs provide an entry point to a group of stocks that are very different from their pre-21st century predecessors.

In 1999, the tech-heavy Nasdaq index was trading at 178 times trailing earnings, while it's at 12 times today. Many companies in the index were big-idea, small infrastructure start-ups born from the dot-com boom.

By contrast, the companies that dominate the market today, such as Apple, Microsoft and Hewlett-Packard, have been churning out rising earnings for years. They've weathered market downturns as well as, if not better than, the broader stock market. Many of them have excess cash flow and pay dividends.

"With large cash balances, increasing dividend payments, solid management and tight inventory controls, the tech sector is far more stable than it was in the last 1990s environment that so many still remember," says Brad Sorensen, Schwab's director of market and sector analysis.

Sorensen says the technology sector is the only group the firm covers that could outperform the rest of the market in the coming months. After holding back on capital improvements in the last few years, these companies appear to be spending again, and they will look to upgrade their technology first. Their excess cash leaves room to increase dividends and pursue mergers and acquisitions, while the companies' financial strength has given the stocks greater stability during market downturns than they've had in the past.

Despite the run-up in these stocks, some analysts believe there is still room for further appreciation. In a March report titled Tech-Well-Loved But With Good Reason, Bank of America research analyst Savita Subramanian noted that "tech valuations remain near their cheapest levels going back to 1995. At 12.8 times 2012 consensus earnings, tech is trading roughly in line with the market." Even excluding the tech bubble years, 1998 to 2001, the group's current price-to-earnings ratio is more than 30% below its historical average and well under its historical 24% premium to the market, she added.

But Subramanian also cited problems that could lead to short-term volatility in this group, which has a history of bouncing around more than most others. While technology companies have a strong presence in emerging markets, they derive an average of 25% of their revenues from the struggling euro zone. Government spending cuts could impact sales; and while a lower U.S. corporate tax rate would certainly help their bottom line, sectors that derive more of their revenue from sales in the U.S. would get a bigger boost.

The Apple Factor
Investors who think the sector could outperform the overall market might see buying opportunities in technology's periodic dips. But those pursuing that strategy by investing in technology ETFs should consider that the stocks already make up a significant portion of many broad-based indexes.

The Standard & Poor's 500, for example, has a 21% allocation to information technology-nowhere near the record 30% weighting the index had just before the market crash in 2000, but a figure still worth keeping an eye on.
And while these companies sometimes separate from the pack in near-term performance, their long-term correlation with the S&P 500 is north of 90%. That makes the ETFs more useful as shorter-term tactical plays than longer-term diversification tools.

With $9.3 billion in assets, the Technology Select Sector SPDR fund is by far the largest and most actively traded gateway to the group. Two other popular tech ETFs are the Vanguard Information Technology (VGT) fund and the iShares Dow Jones U.S. Technology Sector (IYW) vehicle.

While all these funds focus on large-cap technology stocks, they differ in some respects. The SPDR and Vanguard offerings have razor-thin expense ratios of 0.18% and 0.19%, respectively, while iShares charges 0.47%. The SPDR portfolio, which has 81 names, has an average market cap of $107 billion, while the Vanguard fund has $48 billion and 413 stocks. The iShares ETF falls somewhere in the middle of the pack, with 158 names and an average market capitalization of $89 billion.

Apple, whose stock price rose from $310 in June 2011 to more than $600 in March 2012, has for the last year been a powerful driver of the performance in the indexes these ETFs track. The stock now accounts for 20% to 25% of assets in the three exchange-traded funds.

Surrounded by a sea of iPhones and iPads, Apple bulls may not mind that level of concentration. Even with the run-up, analysts still find lots to love about the stock.

"We're maintaining a buy recommendation on Apple," says Scott Kessler, an analyst with S&P Capital IQ. "The company has succeeded in retail stores where others have failed, and it's able to design, promote and improve on products in a way that others in the industry have trouble replicating."

Kessler says the stock, which is trading at around 15 times estimated 2012 earnings, hasn't reached overpriced territory yet. "That's just a slight premium to the overall market, and Apple has much better growth prospects than most companies," he says.

In his latest report on the stock, Morningstar analyst Michael Holt notes, "Apple's near-term momentum continues to look unstoppable. Triple-digit growth rates will abate, but Apple still enjoys a long runway of profitable growth."
But Holt also notes the company faces challenges, including the possible long-term impact of co-founder Steve Jobs' death and Apple's heavy dependence on revenue from the iPhone. The stock's sharp pullback in early April reminded investors that the venerable tech giant, like any stock that's had a particularly strong run, is vulnerable to profit taking.

Aside from Apple, a number of tech ETFs have up to 60% of their assets in top 10 holdings such as Microsoft, IBM, Google, Intel and Oracle. For those who aren't comfortable with the big presence Apple and other stocks have in these ETFs, or who want to spread their bets by emphasizing more mid-cap names, Rydex's Guggenheim S&P 500 Equal Weight Technology ETF (RYT) gives roughly equal weighting to the 71 constituent stocks in its index. Without a big bite of Apple, it hasn't performed as well as the market-cap-weighted ETFs over the last year, but that could easily change if the stock hits a rough patch.

Further afield are ETFs offering more focused plays than those following the broad technology indexes. The semiconductor group, for example, has eight ETFs following it, including the most volatile of the group, the Direxion Daily Semiconductor Bull 3X fund (SOXL). This ETF uses leverage to amplify returns; it was up 50% in the first three months of this year. The Market Vectors Semiconductor fund (SMH) is a popular concentrated bet on the 25 largest semiconductor companies in the U.S. It has a 19% weighting in Intel. With an average daily trading volume of 1.6 million shares, it is one of the more actively traded tech ETFs. Another offering in the group, the SPDR S&P Semiconductor fund (XSD) is more spread out with 49 holdings and roughly 2.5% of its assets in each position.

A few ETFs, such as the iShares S&P Global Technology fund (IXN) and the SPDR International Technology Sector fund (IPK), cover overseas companies. The iShares fund sticks closer to home, however, with more than 77% of its assets in U.S. companies, while the SPDR ETF has a more foreign flavor, holding 38% of its assets in Japanese companies and another 34% in European ones. But its small asset base of just $15 million and its average daily trading volume of 1,846 shares could make liquidity a problem.

More aggressive investors who don't want to take the plunge into individual small-cap or newly public technology securities might consider a few ETFs that offer a more diversified approach to those areas. In an April report, Zacks ETF analyst Eric Dutram highlighted two offerings that fall into this category.

The ETRACS Next Generation ETN fund (EIPO) follows a basket of firms involved in social networking, Internet software and Internet services. With about one-third of its assets in foreign companies, it also offers some international exposure. The Global X Social Media Index ETF fund (SOCL) is based on an index of companies involved in social networking, file sharing and other Web-based media applications. Small and mid-cap names make up about half of the portfolio. Because both these ETFs have very thin trading volume, their bid-ask spreads bear watching for anyone considering a purchase.