Technology funds are ready to prove to investors that they've learned their lesson, come back with stronger fundamentals and seize on a development that rivals the Internet, according to Rudy D. Torrijos III, a vice president for emerging growth at Delaware Investments.
The question is whether the markets are yet willing to give technology another chance.
"The last new-new was the Internet, a.k.a. the Bubble', our dreams and aspirations" said the Philadelphia-based portfolio manager during a presentation in New York earlier this month.
But that bubble burst in March 2000, and brought investors living in la-la-land crashing back to earth. "We learned what tech was," Torrijos said. "Tech is not a land-grab, or land-shove. What matters is how much profit you can make in technology."
It sounds like an obvious investment strategy; but it is a huge divergence from the way Internet companies were valued six or seven years ago. Not only do technology companies today have stronger foundations, but the sector, overall, is poised to take off, Torrijos argued, because of something called Application Networking, also known as "Internet2.0" or "Web2.0," the next "new-new" with the potential impact of inventions such as the mainframe computer, the television and even the telephone.
Application Networking will allow people to access any data they seek-from an MP3 song, to video footage to a spreadsheet saved on a computer at their offices - from anywhere, via a television, mobile phone or PDA.
"The technology is available right here, right now and cheaply," said Torrijos, who noted that many devices cost less that $200.
What's more, after the millennial so-called Y2K scare, technology managers at large companies and institutions, for example, have been slow to upgrade equipment and software.
"There have been five years of underinvestment," Torrijos said. And the world is ready for an upgrade.
When it comes to the technophile's next big new product, the first company to introduce it with a price and package that appeals to consumers generally wins 60% of the market share. The runner-up gets 30%, and innumerable underdogs fight for a shred of the remaining 10%.
In cases where the next big-thing is a single product, such as the high-function MP3, which Apple has clearly dominated with its iPod, that leaves few companies for investors to choose from.
New Product Pipeline
But the Application Network is a completely new infrastructure, and harnessing its power will demand a host of new products, from software to semiconductors. In addition, it opens up the hardware market to scores of new iterations, since devices will have to be Internet-ready to compete, Torrijos said. "Telcos are building the largest Ethernet in the world," he said. Being on the forefront, cable and telephone companies will help give them a head start in angling for new customers, he said.
All this means fierce competition among technology companies, but plenty of opportunities for investors.
Unlike the Internet bubble of the late 90s, the companies that compete in today's market are those that have solid balance sheets and products to prove themselves, not just ideas. Also in the interceding years, regulations, such as the Sarbanes-Oxley Act, have made far more stringent the requirements public companies must meet, and the assurances investors can glean from their filings, Torrijos said.
Gone are the days of secret options that Internet company executives became notorious for during the last run up. "It's a problem in perception and a problem in reality," and most money managers won't tolerate it, he said. "Technology investing is about hope."
It's also about discipline, and managers have learned about that, too. "If a company misses its expectations, that's a reason to sell," said Torrijos, who said he interviews the chief executives of between 200 and 300 companies each year. "If a company misreads consumer demand, that's a reason to sell," he said.
But Lipper Senior Research Analyst Don Cassidy questioned whether the market has reason enough to buy. "Individual investors have a long memory of pain," he noted. "[Technology] is the dog that bit them, and many may be asking, Am I going to walk down this side of the street again?'"
Since the Big Burst, investors as a group have punished technology funds by withholding their money. In fact, the $180 billion sector is still suffering net redemptions five years after its missteps, Cassidy said.
"You can have a good month in the market overall with every sector of funds having inflows, and there will be a dribble of outflows in tech funds," he said. Even in the high-volume April, inflows to technology funds were only $38.7 billion, compared to $62.5 billion to real estate and $55.5 billion to health and biotechnology funds.
Torrijos argues that the years of underinvestment have left the surviving companies lean, mean and perhaps undervalued. Consequently, technology might even be a safer place than many better-trusted sectors during a market downturn.
"They are not going to get slaughtered like natural resources or emerging markets," Cassidy conceded, but technology in general remains fickle. "Technology changes so fast that any individual company can go down quickly," he said. For those seeking shelter, commercial real estate investment trusts (REITs) or even Treasury Inflation Protected Securities (TIPS) still trump technology, Cassidy said.
The other challenge technology funds face, perhaps more than other sectors, is consumer confidence. "Technology is highly correlated with the growth of the economy," Torrijos noted. "You need a strong economy."
Even if everyone wants the ability to access files stored at their office through the cable box in their bedrooms, technology remains highly discretionary, and people will wait if the economy is doing poorly, or consumers perceive it to be. As a result, even those technology funds with the most promising portfolios will be stymied.
Neil Wolfson, senior vice president and chief investment officer at Wilmington Trust Wealth Advisory of Wilmington, Del., said the economy is sound. "The economy is in the later stages of expansion," he said. Wolfson, like Cassidy, suggested REITs and TIPS to help ride out the market downturn. "The growth rate might be slow, but it's not going negative," Wolfson said.
But in the face of rising interest rates, and a tumbling market, investors seems unconvinced.
"Even since a month or six weeks ago, the market psychology has really changed," Cassidy said. Rather than waiting around to determine whether the most recent tumble is simply a market correction, many investors are already acting as though a full-blown recession is underway.
"There is a bit of a drag, and that tells you where investors' mindset is in terms of technology," Cassidy said.
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