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Tech funds spread the risk

Investors who are rattled by the bungee jump that sent some tech stocks briefly plunging this week may consider diversifying from individual stocks to tech-focused mutual funds.

Investors who were rattled by the bungee jump that sent some tech stocks briefly plunging this week may consider diversifying from individual stocks to tech-focused mutual funds.

Despite the tech-heavy Nasdaq composite index taking a beating in the final days of the first quarter, some technology funds managed to post gains of more than 40 percent. That compares with a 10.7 percent gain for the Nasdaq and 3.8 percent decline for the Dow Jones industrial average.

"If you buy a tech fund, you'll naturally be more diversified than if you struck out with your own basket of stocks," said Christine Benz, a senior analyst with mutual fund research firm Morningstar. "Funds are better able to mute some of the volatility."

Benz, who specializes in tech funds, said investors may be comforted by the army of analysts who support portfolio managers, especially during volatile times.

"At a time like this, when the markets are sorting out the speculative companies from those with great fundamentals, investors may find some comfort in knowing their fund has a deep number of analysts who can sort all this out," she added.

But funds also have their drawbacks during rough-and-tumble market days. Portfolio managers may be forced to sell stocks they favor to pay back investors who begin cashing out, Benz noted. Individual investors, however, have the choice to wait it out with their favorite stocks.

Although past performance is no guarantee of future returns, it is helpful to see which funds are doing well and why.

A boom in the semiconductor industry helped propel several of the top five performing funds far ahead of the Nasdaq last quarter, while transitioning out of large cap companies gave another fund an edge.

During the quarter, Alpha Analytics Digital Future fund managed to post a 48.2 percent gain--giving it the title of Morningstar's best-performing technology fund. The fund, which was formed in December, was followed by Rydex Electronics Investor fund (43.5 percent), Fidelity Select Electronics fund (42.1 percent), Red Oak Technology Select (40.8 percent) and Firsthand Technology Value fund (40.8 percent).

Alpha Analytics' fund is a newcomer to the technology sector,

Top Five Tech Funds
Morningstar's top five technology mutual funds based on first-quarter results. Top holdings are based on the most current information supplied to Morningstar.
Fund (ticker) % gain
1. Alpha Analytics Digital Future (N/A*)
Top 5 holdings: Qualcomm, JDS Uniphase, CMGI, DoubleClick, SDL
2. Rydex Electronics Inv (RYSIX)
Top 5 holdings: Intel, EMC/Mass, JDS Uniphase, Texas Instruments, Motorola
3. Fidelity Select Electronics (FSELX)
Top 5 holdings: Micron Tech, Microsoft, Texas Instruments, Analog Devices, Altera
4. Red Oak Technology Select (ROGSX)
Top 5 holdings: JDS Uniphase, EMC/Mass, Network Appliance, Cisco Systems, Exodus Comm
5. Firsthand Technology Value (TVFQX)
Top 5 holdings: TriQuint Semiconductor, Applied Micro Circuits, PMC Sierra, Digital Microwave, AT&T
*No ticker available because of the fund's size
Source: Morningstar
having just completed its first full quarter. The fund splits the stock picking duties and market timing responsibilities between co-managers Mike Cohen and John Gipson. The $3 million fund is one of three in the Alpha family.

"Although we liked the fundamentals of Sun (Microsystems), we got out of that position in February because our model showed that large cap stocks were going to underperform," said Gipson, who noted they sold the stock at $91.50, which is about where it is trading today.

Cohen said he takes a top-down approach to picking the pool of stocks.

"I find sectors that I like and pick the top performers in each sector. I also look at sectors that have a high barrier to entry," he said.

SDL, which makes products to help transmit data and voice over fiber-optic networks, was one of Alpha's top holdings and virtually doubled over the course of the quarter.

"The have one of the better research and development teams and are in one of the hottest spaces with earnings growth," Cohen said. "Also, their barrier to entry is high because of the expertise that's required to make their complex components and modules."

Rydex, Fidelity and Firsthand got a boost from chip and equipment makers in the first quarter; The Standard and Poor's Electronic Semiconductor index soared 43 percent in the period.

"Our fund has about 50 percent in semiconductors, and Intel is the largest holding in our fund," said Dan Gillespie, senior portfolio manager for the Rydex Fund Family, which includes 15 sector funds and six index funds. "We pick our universe of stocks and then weight them based on market cap, liquidity, being a pure play and leadership."

In picking holdings, he said the fund focuses on established companies that can capitalize on market trends.

"There may be times when smaller caps outperform our stocks, and we probably won't hit a lot of home runs, but if the sector gets spooked, the smaller stocks tend to crash and burn first," he added.

Telecommunications equipment stocks comprise 20 percent of the fund, which has $297 million in assets. Gillespie said he expects semiconductor and telecom equipment makers to lead the way in fueling the technology boom.

Rydex is also placing bets on the Internet. The company recently said it is creating the Rydex Internet fund, which will focus on content, commerce, equipment, Internet service providers, software and support.

Meanwhile, Firsthand's Technology Value fund also received a strong run from the chip and communications sectors. Semiconductor and chip equipment makers comprised 37 percent of its $3.6 billion portfolio.

But unlike Rydex's sector funds, Firsthand looks at various trends throughout technology and seeks hidden gems.

"If we're looking at a trend in wireless, we're more likely to invest in component makers than a wireless company," said Kevin Landis, chief investment officer for Firsthand, which operates five technology funds.

Citing another example, Landis noted the company wanted to invest in the DVD boom but didn't find a lot of good candidates among the device makers. So Firsthand chose to invest in a small chip company that supplies DVD makers.

"We work our way up the food chain," he said. "That might explain why we have a lot of semiconductor and communications equipment stocks."

Of course, investing in tech funds is no guarantee of big profits. Several tech funds were caught in the Nasdaq's downdraft.

Potomac Internet/Short fund, which shorts Internet stocks, lost 13.71 percent of its value and topped the list of the worst-performing tech funds in the quarter, according to Morningstar. And although the Nasdaq got hit in the final weeks of the quarter, overall the index was up for the three-month period.

That fund was followed by Potomac Internet Plus, which declined 7.9 percent in the quarter, and the Jacob Internet fund, which posted a 6.53 percent decline thanks to holdings such as InsWeb, NetZero and StarMedia Network.