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Taking the tech out of tech mutual funds

Amid the market carnage last year, only four tech mutual funds managed to squeeze out gains--and the secret to their success was in paring down their tech holdings.

Amid the market carnage last year, only four tech mutual funds managed to squeeze out gains--and the secret to their success was in paring down their tech holdings.

It was a year marked by an average 33 percent decline for tech funds, signaling the first time since 1984 that tech ended in the red, according to mutual fund research firm Morningstar. Internet funds also took a severe beating, averaging a 51 percent drop for the year.

That's a sharp contrast to the 135 percent gain the group averaged the previous year.

"The few tech funds with gains had a lot of leeway to go away from tech," said Christine Benz, a senior Morningstar analyst.

The Icon Information Technology fund was one example.

The $34 million fund, one of 14 managed by Meridian Investment Management, rotated out of semiconductor, semiconductor equipment makers, computer hardware companies and communications equipment makers early last year. In its place, the fund rotated into industries that use technology to provide services.

Some of its new holdings include e-commerce processor Concord EFS and old defense company Litton Industries, said Craig Callahan, chief investment officer for Meridian.

"When tech first dropped in March and April, we didn't go back in," Callahan said. "The stocks weren't cheap enough for us. In the fall, when the markets fell a second time and tech dropped again, we still didn't go back in.

"The stocks are cheap enough now and it's caught our attention, but we still don't think it's their time. There's no upside in the near term, and we'll likely stay in these fringe technology companies for the coming months."

Icon managed to post a 14 percent gain for the year, one of four that stepped into the black from a field of 120 funds.

Potomac Internet Short Fund, an index fund that makes money when stocks go down, gained 45 percent last year, followed by Pimco Global Innovation Fund, a 1-year-old, $310 million fund, with a 41 percent jump. Kinetics Internet New Paradigm Fund, a broadly defined fund with the Washington Post Co. and IMS Health among its larger holdings, posted a 4 percent return for the year.

Icon Information Technology, launched in 1997, takes an "intrinsic value" approach to sizing up companies. This ranges from compiling information on a company's future earnings growth to examining the rating on its corporate bonds. The fund then groups these companies into industries and rotates in and out of industries based on market conditions, Callahan said.

Few gainers
Losses flowed from tech mutual funds last year, leaving only four with gains. Here's a look at the top five winners and losers in 2000.

Potomac Internet Short Fund +45.4%
Pimco Global Innovation Fund +41.4%
Icon Information Technology Fund +14.0%
Kinetics Internet New Paradigm Fund +3.9%
Sit Science & Technology Fund -6.6%

Jacob Internet Fund -79.1%
Potomac Internet Plus Fund -77.3%
Internet Index Fund -72.2%
ING Internet C Fund -69.4% Pure Play Internet Fund -66.6%

Source: Morningstar
Some of the fund's home runs last year included wireless company Qualcomm, which the fund sold for $120 to $150 a share in January and February. Icon acquired shares as low as $6.85 back in late 1998. Meanwhile, the fund acquired Litton in the fall at $49, and the stock is up around $78 today.

And like a number of funds last year, Icon increased its cash position to levels higher than normal. Icon increased its cash position to as high as 25 percent of its assets but has since brought it down to around 6 percent.

"We had a high cash position because we sold our position in a lot of companies in February and didn't find any immediate replacements. That helped buffer our performance in March and April," he noted.

Pimco Global Innovation Fund, one of 30 Pimco funds, has the ability to invest in non-tech companies that are innovative, said Dennis McKechnie, who is a co-portfolio manager with Jiyoung Kim. Biotech companies, for example, represent 21 percent of the fund.

Last year, the best move Pimco made was migrating out of semiconductor-related stocks, as well as cell phone and fiber-optics companies, McKechnie said. The fund, as of late November, had several pharmaceutical and health care companies among its largest holdings, along with storage management maker Veritas Software and management software company NetIQ.

Extreme Networks also proved to be a winning move for the fund. During the first quarter, Pimco bought Extreme when it was trading in the high $30s and sold a portion of its holdings in the third quarter when the stock was at $90. Today, Extreme is trading around $40.

McKechnie said his fund focuses all its research efforts on fundamental analysis, such as management changes, product cycles and the health of a company's customers. The fund also reviews macro indicators, such as the state of the economy and its projected path.

"Our sense is the economy will continue to get worse for the next several months, but there is light at the end of the tunnel," he said. "Fiber optics may work once the economy improves, because their customers are long-distance providers whose customers' very business depends on the economy."

Among the surprises during the year, Morningstar's Benz noted that large diversified funds, such as Janus Global Technology and T Rowe Price Science and Technology, did not fare well.

"Usually the large diversified funds are backed by good research teams and are considered less risky because they're more diversified. But that didn't happen, Benz said. "They were somewhat penalized because they didn't focus their stocks on narrow categories like storage stocks, which did well this year."

She added that mega-cap stocks such as Microsoft and Intel also failed to perform better than some smaller large-cap stocks like i2 Technologies and BEA Systems.

"Mega-caps weren't the place to hide," Benz said. "There were few places tech investors could go last year."