Seek Shelter in Tech Funds, as Long as You're Patient

But don't let those push-button profits obscure the risk.


Tech funds are not for the timid or impatient.

True, funds specializing in high-tech businesses have been going gangbusters this year—averaging returns of almost 13 percent, far outpacing the 5.75 percent gain tallied by the broadest stock fund, according to Lipper. And those brave souls who invested when things looked bleak early this decade have been handsomely rewarded. Since 2002, tech funds have averaged returns of more than 16 percent a year, at least 2 points above the Dow Jones Wilshire 5000 index.

But measured over the past decade, tech is a darker story. The millions of investors who became infatuated with tech during the boom of the late 1990s are still suffering heartbreak. While the most diversified equity funds have now recovered their losses from the bear market that followed that boom, tech funds fell more steeply and haven't climbed back; even with the recent rally, many tech fund investors are still down by half.

Mindful of that long-term performance, managers of some of the hottest tech funds warn away clients hoping for quick gains in, say, junior's college fund. "If you did that in 1999, you'd have to say, 'Jim, when you're 30, you can go to college,' " says Kevin Landis, whose FirstHand Tech Value fund lost about 50 percent in 2001 and again in 2002—but is up more than 30 percent over the past 12 months.

Landis, whose value portfolio is priced at 23 times earnings—a premium over the broad market average of 15.6—says tech fund investors should realize they are paying for growth prospects. One of the value fund's biggest holdings, Cypress Semiconductor, is being valued by the market at only about $4 billion, even though it is sitting on about $800 million in cash and owns 50 percent of a solar technology company valued at $6 billion, Landis notes.

Tech investors are also paying for a possible buffer against other economic cycles, such as a real-estate bust, says Chris McHugh, whose five-star Turner New Enterprise fund is up more than 38 percent in the past year. That's because tech is resistant to problems such as the subprime meltdown, which has forced many financial and real-estate companies to slash their earnings and outlooks. Booming global demand for replacement computers, new cellphones, and online services, by contrast, has pushed tech company earnings up faster than analysts had expected. "People thought Google's IPO [closing price of $100] was nuts," McHugh points out. But the stock is now trading above $500. And Google says advertising revenues are growing at 40 to 50 percent a year. That makes the stock's current P/E ratio of 25 times next year's projected earnings look downright cheap, McHugh believes.

Five Funds for Technophiles

Since studies show that the vast majority of investors don’t earn even the average return of the broad stock market, advisers say the safest thing to do is to simply put your money in a total stock market index fund. But investors who want to risk a little extra mad money on the booming technology sector have several options. Here are a few of the best-performing funds.

Name of fund Type of fund 1-year return 3-year 5-year Expense Ratio
Columbia Technology Managed 24.92 24.06 26.51 1.20
Turner New Enterprise Managed 38.24 24.54 26.12 1.60
Allianz RCM Technology Managed 29.33 18.75 20.90 1.64
iShares S&P GSTI Networking ETF 22.50 11.43 22.93 0.50
E*TRADE Technology Index Index 24.62 13.36 14.02 0.60

Source: Morningstar

Investors who have the patience and stomach to bet on tech, but don't want to pick individual stocks, have four basic choices:

Managed funds. There are dozens of plain-vanilla mutual funds, in which professional managers pick stocks. Three top-performing tech funds on Morningstar's list are Allianz RCM Technology, Columbia Technology, and the Turner New Enterprise funds.

Index funds. The simplest strategy is to put a little money in one of the funds that buy shares in every technology-related company. E*TRADE Technology Index returned 25 percent over the past 12 months, and it charges an expense ratio of just 0.6 percent. The Vanguard Information Technology exchange-traded fund returned more than 23 percent in the same period, and it has a rock-bottom expense ratio of just 0.25 percent.

Enhanced index funds. Investors who like to ride roller coasters with their hands in the air can gamble their money on the Internet Ultrasector ProFund, which uses debt to magnify the swings in the Dow Jones US Technology Index by 50 percent. That's been great for the recent run-up: The fund has a five-year return of more than 36 percent. But that leverage turns deadly in a down cycle. The fund lost more than 90 percent of its value in the 2001-02 bust. That "insane volatility" compels Russel Kinnel, Morningstar's director of mutual fund research, to warn investors away from this option. ProFund's high expense ratio of 1.5 percent is another deterrent.

HOLDRs. Merrill Lynch invented these hybrids of funds and stocks in 1998. Basically, they're static baskets of stocks that avoid the churn and tax consequences of mutual funds. The Internet Architecture HOLDR, which has 20 stocks but is dominated by stakes in IBM, Hewlett-Packard, and Cisco, is up 45 percent in the past year. Because they are so concentrated and unusual, Morningstar analyst Jeff Ptak recommends HOLDRs (for holding company depository receipts) only for active, risk-tolerant investors who can monitor them closely.