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Think Twice Before Buying a Pure Technology Fund

The tech category has real limitations.

William Samuel Rocco, 03/31/2009

It's certainly understandable if technology funds have caught your attention. They've performed relatively well as stock markets have continued to struggle in 2009. In fact, while most diversified domestic-equity and international-stock funds have lost between 10% and 15%--and some specialized offerings have dropped significantly more than that--tech funds have posted a 2% gain for the year to date through March 19. Latin America offerings are the only other category of equity funds that has managed to eke out a gain this year, and they're up just 3%.

Tech stocks definitely aren't immune to the many macroeconomic and other problems that are roiling the financial world--and they could very well struggle over the short to midterm--but there are a number of fundamental reasons to be optimistic about their long-term prospects. For starters, though they didn't suffer quite as much as energy and certain other types of issues, they did incur huge losses in 2008, and many of them are attractively priced at present. Most tech stocks are trading at roughly 12 to 13 times their prospective earnings. And while that's not quite as cheap as certain other types of stocks, it's only moderately higher than the S&P 500 Index, it's quite reasonable in absolute terms, and it's far lower than these stocks have usually traded at in the past.

What's more, many tech stocks boast strong competitive and financial positions as well as fetching prices. According to Morningstar's equity research, there are scores of software, hardware, and other computer-related stocks with both economic moats and good financial-health grades, because they have dominant market shares, copyrights, or other attributes that give them lasting advantages over their rivals plus limited leverage, healthy cash flows, and ample cash on their balance sheets. Included among that number are several of the most recognizable tech bellwethers, including IBM IBM and Oracle ORCL.

Several Good Managers Are Buying Tech Stocks
As would be expected, many good technology managers have noticed that there are lots of high-quality bargains in their purviews these days. For example, Walter Price and Huachen Chen, the seasoned skippers of Allianz RCM Technology DRGTX, have shifted assets toward Microsoft MSFT and Qualcomm QCOM as well as toward IBM and Oracle. And Paul Wick, who runs Seligman Communication & Information SLMCX and who is the longest-serving manager in the technology category, has added to his positions in some of the same names and some other industry leaders.

More significantly, given that they're not confined to the technology space, many first-rate diversified-equity managers have been finding lots of opportunities in the computer-related industries. The team at Dodge & Cox Stock DODGX, which is one of the best in the large-value category, has been buying and adding to an array of technology stocks over the past few quarters. That fund now has 16% of its assets in such issues. The excellent squad at Manning & Napier Equity EXEYX has built sizable positions in Google GOOG, Microsoft, Cisco CSCO, and other market leaders, so that large-blend fund has nearly one third of its assets in tech names. And Stephen Pesek of MFS Core Growth MFCAX, who is one of the more seasoned and skilled skippers in the large-growth group, has boosted his stakes in a number of hardware and software holdings in recent months. That fund has 30% of its assets in computer-related stocks.

Meanwhile, it's not only good diversified domestic-equity managers that have been putting a significant amount of money to work in technology stocks. The talented manager of Oppenheimer Global OPPAX, Rajeev Bhaman, has added to his positions in Microsoft and in SAP SAP, the German provider of enterprise resource planning software, so that world-stock fund has more than one fourth of its portfolio invested in computer-related issues. And the skilled manager of Janus Overseas JAOSX, Brent Lynn, has boosted his exposure to hardware firms from Canada and elsewhere, raising that foreign large-growth fund's stake in that sector to nearly 20%.

But This Doesn't Make a Tech Fund Right for You
While all this might have you thinking about purchasing a dedicated technology fund, there are three reasons to be wary of doing such a thing. First, you probably already have a fair amount of technology exposure in your portfolio. Vanguard 500 Index VFINX devotes roughly 15% of its assets to computer-related stocks, and many large-blend funds and most large-growth offerings normally have significantly more than that invested in such issues. And although most domestic-value and international-stock funds typically have moderate stakes in tech, some of them consistently sport sizable hardware and software positions. Ameristock AMSTX is a good low-turnover large-value fund that has maintained a hefty tech weighting for years, for example, while American Funds New Perspective ANWPX, a topnotch world-stock offering, has done the same.

Second, the tech exposure that you're getting through your existing funds may well be increasing. The investors mentioned above certainly aren't the only good equity managers that have been finding lots of the opportunities in the software and hardware sectors these days. Ron Sloan of AIM Charter CHTRX has added to his positions in the security-software leader Symantec SYMC, the dominant chipmaker Intel INTC, and other computer-related stocks, and that fine large-growth fund has more than one fifth of its assets in tech issues. The managers of many other core funds are making similar moves, as are the skippers of many supporting and specialty offerings. The team at Buffalo Mid Cap BUFMX and Justin Leverenz of Oppenheimer Developing Markets ODMAX have added to their software and hardware exposure, for example, so both of those good funds have roughly 20% of their assets in computer-related names.

Third, most technology funds have significant weaknesses themselves. Because of the explosive nature of computer-related stocks as well as their industry concentration, they're much more volatile than all other categories of funds. In fact, they suffered double-digit losses in 25 rolling three-month periods during the decade before their 2008 meltdown. In 10 of those periods they lost 25% or more.

In addition, they're costly, even by the pricey standards of specialty offerings. The median no-load fund has an expense ratio of 1.36%, and the median front-load one has an expense ratio of 1.55%. And the managers of many tech funds have only been in place for a few years and have limited experience running money in the roller-coaster conditions that prevail in the tech space.

In short, despite the many high-quality opportunities available among computer-related stocks these days, investors can comfortably do without a dedicated technology fund. Those who are set on making such an investment should be certain that they limit it to a tiny part of their portfolio, that they have a very long time horizon, and that they can handle extreme volatility.

William Samuel Rocco is a fund analyst with Morningstar.

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