Finding gems in troubled tech funds

No surprise, it's been a tough year for tech investors. But we talked to four fund managers who have found some stock successes.

Technology investment funds are taking a beating, ranking nearly dead last among more than a dozen categories of domestic stock funds tracked by mutual research company Morningstar.

But even though all of the 75 specialty technology funds listed by Morningstar are down year-to-date, some of the portfolio managers have found ways to minimize the carnage, which has seen the category pushed into the red by an average of 19.16 percent as of Friday.

Within tech funds, an index approach has proved to be a more successful strategy in this current climate, as evidenced by the North Track NYSE Arca Tech 100 Index Funds..

"We're kind of a steady-Eddie. We tend to lag when tech is doing really well, but lead when it's not," said Don Nesbitt, chief investment officer at Ziegler Capital Management, which advises the North Track NYSE Arca Tech 100 Index Funds. "Our fund is for people who want tech in their portfolio for the long term."

Don Nesbitt, North Track portfolio manager Ziegler Capital Management

The North Track NYSE Arca Tech 100, although down 9.11 percent year-to-date, has been able to outperform the Nasdaq, which is down 13.4 percent year-to-date, and the total returns for specialty technology funds listed on Morningstar, which as previously stated is down nearly 20 percent.

"The recipe for our success is the way the index has been put together," Nesbitt said. "We've always had stocks across a wide variety of industries and we use a price-weighting scheme, instead of being cap-weighted like the Nasdaq. Whereas Google and Microsoft are a large part of the Nasadq, we don't allow any one stock to be a large part of our portfolio."

For example, North Track NYSE Arca Tech diversifies its holdings by limiting a single stock to less than 10 percent of its portfolio and keeping a lid on its top five holdings by restricting their total representation in the portfolio to less than 25 percent.

Two stocks that have given a lift to Nesbitt's fund, which has roughly $300 million in assets, are Qualcomm, which is up 18.73 percent year-to-date, and Digital River, up 35.86 percent.

Both stocks were selected from the NYSE Arca Tech pool because of their leadership position within their respective industries, Nesbitt said. Digital River, an e-commerce software provider, has seen its stock get a jolt from stronger than expected second quarter results, while Qualcomm got a shot in arm after reaching a settlement in its long-standing patent lawsuit with Nokia .

Other top 10 tech funds that are currently outperforming the Nasdaq and the average Morningstar specialty technology fund category include AFBA Five Star Science & Technology, which currently ranks as the fourth, Seligman Communications and Information, which ranks sixth, and the Franklin Technology Fund, which ranks eighth.

A common theme for three of the four mentioned funds has been investments in Qualcomm. Franklin and Seligman both received a boost from their investment in the communications chip maker.

For J.P. Scandalios, portfolio manager of the Franklin Technology Fund, Qualcomm and chipmaker Microsemi both provided double-digit returns to date.

"At the start of the year, I had a strong conviction with these," said Scandalios, who also has served as a longtime chip analyst and oversees a team of technology analysts who work on the fund. "I felt Qualcomm had a huge overhang, due to the Nokia litigation and felt that at some point it would be resolved and whatever the resolution, the market would be happy."

J.P. Scandalios, Franklin Templeton portfolio manager Franklin Templeton

Several factors Scandalios took into consideration included the potential upside Qualcomm's revenues would see if Nokia had to pay royalties; a reduction in costs by eliminating the Nokia litigation; and an expansion of the chipmaker's valuation by removing the uncertainty that could come from litigation.

Microsemi, which develops semiconductors to control power, has gained 17.1 percent year-to-date. Scandalios, who noted he's been in and out of the stock over the past decade, likes the small-cap stock because half of its business comes from military, aerospace and satellite contracts, which tends to be resilient against downturns in the general economy.

The company is also diversified with a line of high-growth business, such as selling its technology to notebook and wireless LAN makers.

"Early this year, Microsemi was selling for less than $20 (a share) and knowing them and doing a valuation and taking a longer view, I was willing to be patient," Scandalios said, noting patience is a key in tech investing. "Technology investors can be so skittish. If a company misses their quarterly guidance, the stocks get annihilated."

Seligman Communications and Information not only benefited from Qualcomm's performance, but also the security sector with investments in Symantec, up 34.5 percent year-to-date, and Check Point Software Technologies, up 13 percent.

Growing concerns of security threats and regulatory compliance requirements, like Sarbanes-Oxley, prompted investments in the two security players, said Paul Wick, Seligman Communications portfolio manager.

Paul Wick, Seligman portfolio manager Seligman Investments

Alternative energy was a category that yielded AFBA Five Star Science & Technology a large boost to its fund with its investment in solar power company Energy Conversion Devices. That stock is up 84 percent year-to-date.

"The drivers of alternative energy are laws that have been passed out of a concern for global warming and carbon. If those laws didn't exist, these sources of energy would have to compete on their own merits and there are cheaper ways to generate power on this earth," said Tom Laming, chief investment officer of TrendStar Advisors which advises the AFBA Five Star Science & Technology.

Tom Laming, AFBA portfolio manager TrendStar Advisors

He noted that if laws and subsidies were removed regarding alternative energy, the cost to produce a kilowatt of power via solar or wind energy would be far more expensive than other current means, reducing the attractiveness of investing in alternative energy. But given that type of pull back is not anticipated in the near future, stocks of some alternative energy companies that were early players to the industry are enjoying the benefit.

In the future, Laming expects to see LED lighting replace incandescent bulbs over time. And as such a transition takes hold, the portfolio manager believes his investments in Cree and Daktronics may pay off. Driving the shift to digital lighting, where it is currently used in automobile taillights and traffic signals will be a reduction in cost to buy the lighting, which is more energy efficient, Laming said.

For Wick, companies in his portfolio that he has high hopes for in the near future include Autodesk with its large presence in animation with its computer-aided design (CAD) software and modest valuation to BMC Software, which operates in three attractive areas: datacenter automation, mainframe utility software, and IT service and helpdesk.

"We're fundamental growth investors with valuation disciple," Wick said. "And despite this economic climate, that strategy doesn't change that much."

 

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