A new study of investor psychology by financial services provider Charles Schwab found that the majority of technology mutual fund owners remain optimistic--despite the fact that nearly all tech funds lost money in the second quarter.
According to the Schwab OneSource Mutual Interest Council survey published today, more than 85 percent of respondents planning to purchase a tech fund in the next six months said they believed it would outperform other mutual funds in the next five years. Fifty-six percent said they expect their tech funds to outperform other mutual funds this year.
Although that is good news to tech companies and fund managers eager to peddle shares, the optimism is not necessarily steeped in the reality of today's decidedly more pessimistic market. Of the 154 tech funds that existed before April 1, only two managed to end the second quarter in the black: Red Oak posted a 3.5 percent gain, and Turner Technology increased 2.5 percent.
Overall, tech funds lost nearly 12 percent in the second quarter, according to research firm Morningstar. By comparison, the tech-heavy Nasdaq composite index slumped 13 percent in the quarter. The Dow Jones industrial average fell 4 percent, and the Standard & Poor's 500 index dipped 3 percent.
Why do investors remain bullish about funds that have been a losing proposition for the past several months?
Fund managers say the optimism reflects a deep change in America's conception of tech companies. Instead of being the high-risk choice of aggressive investors, as they were in the '70s and '80s, tech funds are now considered the blue-chip mainstay for all portfolios--even those of conservative investors and people approaching retirement, who would not have gambled on tech a decade ago.
Many investors plow 401(k) savings into tech funds without monitoring the funds' performance, similar to the way people once were blasé about actively monitoring bonds or stocks of utilities.
"A lot of the exuberance has been because of the amount of press on technology stocks and the fact that so much money has already been made. It's one of those things where success breeds success," said Bill Schaff, portfolio manager for Denver-based Berger Information Technology Fund. "It's behavioral finance."
Behavioral finance and so-called momentum investing--in which people buy shares simply because they are climbing--were the norm throughout the late '90s and in the first months of 2000. But those techniques fell out of fashion in March, when the stock market collapsed and tech stocks were hit particularly hard.
Some economists pinned the blame on institutional investors, who got nervous at soaring valuations of tech companies that had never reported profits. They speculated that mutual fund investors, who tend to take a more relaxed approach to their investments than stock purchasers, would appear less enthusiastic in the next Schwab survey as the pessimism trickles down to Main Street investors.
"We've had a long growth run led by tech stocks for the past five years, and it's been more about psychology than financial fundamentals," Schaff said. "In theory, you should become less optimistic because of the likelihood of reversion to the (historical) mean. Maybe that will happen sometime soon."
Examining the numbers
The Schwab survey, which polled 848 American Schwab customers via email in June, found that 52 percent had invested in a technology mutual fund in the past six months, and 46 percent planned to make additional technology fund investments in the coming months.
By comparison, only 27 percent had invested in tech funds in the first six months of 1999, and 21 percent planned to make additional fund investments for the remainder of 1999. Fewer than 5 percent of respondents redeemed all of their technology fund shares in the past three months.
"April and May were tough times for many tech fund investors," said David Shaver, senior vice president for Schwab mutual fund marketing. "But we are glad to see that our clients are taking a long-term approach to technology-focused mutual funds and not chasing performance or fleeing the sector when times get tough."
Respondents were not entirely blind to market difficulties in the first half of 2000. Although 61 percent of respondents said they were "maintaining an upbeat outlook," 51 percent said their portfolio had not performed as well as they expected so far this year.
Respondents said they expected a mean return of 13.4 percent for their mutual fund portfolio in the next 12 months, while 45 percent expected returns of 10 percent or less.
But some analysts said those numbers, although reflective of the performance of many funds in the past three years, may not be feasible in the next year or over the long term.
Bill Parish, chief investment officer at Portland, Ore.-based Parish & Company, said investors should be extremely cautious of the massive number of outstanding shares of popular tech holdings, including Cisco Systems, which has about 8 billion shares on the market and reserved as options for employees.
"Investors have completely detached themselves from the underlying risk of the funds," Parish said. "People have watered (down) stock and they don't know it."