Stephen Schurr

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Twice-Shy Funds Still Smitten With 'Net's Big Three

Stephen Schurr

Remember the old sleepover party s¿ance game, "Light as a feather, stiff as a board" -- when everyone used two fingers to inexplicably lift a recumbent person?

Well, the fund industry is engaged in a collective game with the big three Internet companies: No one hand is responsible for the levitation of Amazon.com(AMZN Quote), eBay(EBAY Quote) and Yahoo!(YHOO Quote) shares, but they have reached perilously high levels nonetheless.

Many market pundits assessing the meteoric rise of the Net's big three, as well as other phoenix-like Internet risers such as Barry Diller's InterActiveCorp(IACI Quote), notch it up to questionable momentum chasing by mutual fund managers. Indeed, "institutional herding" -- when mutual fund managers dog pile into (or out of) a hot stock or sector as a group -- clearly is at work in the Internet sector.

However, as fund managers renew their love affair with Internet and tech stocks, it appears they're being a bit more prudent about overexposure in an individual fund, according to data provided by mutual fund tracker Morningstar. Of the 4,205 funds tracked by Morningstar, only 86 reported having more than 5% of their portfolios' assets in some combination of the Yahoo!-eBay-Amazon trifecta in the most recent reports. And with a few notable exceptions such as Bill Miller's (LMVTX Quote)Legg Mason Value, the overwhelming majority of the funds are clearly labeled tech funds, such as (ATCHX Quote)Amerindo Technology, which has 35% of its assets in the big three, according to Morningstar.

"The last three years have been a very sobering time, leading a lot of firms to re-examine their risk controls," said Morningstar director of fund analysis Russ Kinnel. "Growth managers have become far more valuation-sensitive."

Net Floats

While it may hearten mutual fund investors to know that few individual funds are loaded to the gills with a few frothy stocks, investors who own shares of the three companies should be alert. The across-the-board ownership of Yahoo!, eBay and Amazon.com is cause for alarm if funds that have been jumping in start getting out at the same time.

The fate of eBay, Yahoo! and Amazon.com shares rest literally in the hands of mutual fund managers, considering the institutional ownership levels of the three stocks. Institutional ownership levels of 45% or above are considered high, according to Patrick J. Dennis, a professor at the University of Virginia who has studied herding behavior among mutual funds.

Institutions own 61% of eBay and Amazon shares and 60% of Yahoo! shares, according to Yahoo! Finance. The percentages are even higher when one examines the float -- the number of shares publicly owned, removing restricted shares. Institutions own 79% of publicly traded eBay shares, 69% of Yahoo! and 88% of Amazon.com.

It's hard to blame the fund industry for dog-piling. So far in 2003, eBay shares have climbed 65%, Yahoo! shares are up 99%, and Amazon.com shares have risen 103%. This has pushed the companies' price-to-earnings multiples to extremely high levels: Yahoo! sports a forward P/E of 93, while eBay's P/E is 76 and Amazon's is 80.

Given that the shares of the three companies are priced for perfection, the big risk is that once managers turn sour on the big three because they cannot meet impossibly high expectations, a long downward selling spiral may commence. Indeed, Yahoo!'s 7% skid the day after posting strong earnings last week signaled that anything less than great news may be cause for concern.

Kinnel says many fund firms have learned a painful lesson about letting their funds get overly dependent on a few stocks. In April 2000, for instance, seven of Janus Capital Group's(JNS Quote) 15 funds counted Nokia(NOK Quote) as its top fund holding. Nokia's downturn, along with downturns in several tech stocks the firm loaded up on, crushed Janus funds in the three-year bear market.

"A lot of fund firms went way too far out on the limb at the markets peak," Morningstar's Kinnel said. "Janus and Putnam realized they had to change things."

Indeed, as of March 31 of this year, Janus' stakes in eBay, Yahoo! and Amazon.com totaled 2.5% of their assets under management, according to institutional-ownership tracker Lionshares.com -- not enough to devastate the funds even if all three stocks cratered at once. (Janus officials didn't return calls for comment in time for publication.)

Janus' relative prudence doesn't mean investors in the three companies should breathe much easier, however. The firm is the second-largest institutional owner in eBay, holding 4.3% of shares outstanding. Janus also owns 3.75% of Amazon shares and 2.91% of Yahoo! shares, making it the third- and fourth-largest institutional owner, respectively.

Concentration

While individual funds may be less vulnerable to overexposure to a single stock or sector, a few funds remain tethered to the fortunes of a few concentrated picks.

Perhaps the best known is Bill Miller and Legg Mason's outsize bet on Amazon.com. Legg Mason funds own nearly 14% of all Amazon.com shares outstanding, and the stock recently accounted for 8.66% of Legg Mason's portfolios, according to Lionshares -- it is the top holding of Miller's ( LMVFX Quote)Legg Mason Value Trust. Another Legg Mason fund, ( FOCTX Quote)Focus run by Robert Hagstrom, had more than 17% of its assets in Amazon, eBay and Yahoo!, according to Morningstar's data.

Hagstrom was on vacation last week and unavailable for comment. But his fund is well-advertised as a concentrated fund -- the skipper makes big bets on about 20 stocks and alerts investors that such concentration may mean short-term volatility. Miller and Hagstrom's funds have been great performers over the long haul, but investors should recognize that the big Internet stakes may mean a bumpier ride.

Such big bets by one institution often serve a grist for the rumor mill. Last week, whispers that a big Amazon owner was looking to sell a block of several million shares put a bit of pressure on the stock Friday. Rumors along those lines are not new.

Meantime, tech funds such as the Amerindo Technology and ( MNNYX Quote)Munder NetNet are by definition heavily invested in the likes of eBay, Yahoo! and Amazon. According to Lionshares, Amerindo's funds had 31% of their assets in eBay -- that only translates to about 1% of all eBay shares, making Amerindo much more vulnerable to eBay than eBay to Amerindo.

Investors looking to buy into mutual funds these days may be lured by tech-heavy funds that have scored by so far this year by riding the momentum of the Internet revival, but individuals would do well to resist the urge to jump into a tech-specific fund -- especially since, as the ownership levels of the big three indicates, most ordinary funds still have plenty of tech already, thank you.

Besides, "hot short-term performance tells you more about the risk profile than skill," Kinnel says.