The Joy of Techs Spurs Unprecedented Boom in Sector Funds

It's a geyser, folks.

The pace of new tech funds spewing from the mutual fund industry's product pipeline is reaching Malthusian levels. At the start of 1998 there were 40 tech funds. Today there are at least 105, with 40 launching so far this year alone. At least another dozen are in the filing process with the Securities and Exchange Commission. This total doesn't even count the more than 10 tech-sector exchange-traded funds or the seven new wireless and telecommunications funds that have already launched this year. The boom carries major implications for investors, the fund industry and the stock market.

"This is one of the watershed changes in the fund industry and it's intensifying risk, rather than mitigating it," says Burt Greenwald, a Philadelphia-based mutual fund consultant with 40 years of industry experience.

Tech Fund Explosion About 75% of the more than 100 tech funds have launched in the last three years. The chart below shows how many funds launched in each of the past 6 years.
1995	1996	1997	1998	1999	2000
4	9	8	11	25	40
Source: Morningstar, MaxFunds.com, SEC filings.

Today, more than $167 billion are invested in tech funds. Among sector funds, that's about four times the total invested in runner-up health care funds. It's also more than is invested in diversified small-cap funds, according to Lipper.

To be sure, the surge in tech sector funds is a natural adjunct of the past decade's tech revolution and attests to the central role technology stocks have played in the 1990s bull run. But with so much money funneling into rather narrow channels, it increases the likelihood that already-pricey tech stocks will see their valuations surge higher as momentum chases momentum.

The trend also raises a compelling question: How many investors really need to heap a tech fund on top of the tech-heavy growth funds they already own? If investors have a market-like portfolio, they already have about a 30% tech position before they buy a tech fund. With all that money staked to the expensive sector, a steep and prolonged tech selloff could trigger a hard landing for stocks, the funds that buy them and the investors who own them.

Returns and In-flows
	1995	1996	1997	1998	1999	2000
Returns	42.9%	20.3%	9.4%	52.5%	135.7%	6.7%
In-Flows ($ mill)	$4,381	$1,758	$1,436	$488	$33,510	$36,300
Source: Financial Research. Data through May 31.

Two factors are helping propel the boom: Investors are chasing last year's triple-digit returns and fund companies are chasing investor dollars.

"The fund industry is seeing all this money chasing tech funds and they're launching more funds to capture it," says Jonas Max Ferris, chief executive and co-founder of MaxFunds.com, a Web site that spotlights new funds.

The average tech fund last year posted a stunning 135% return. Even though tech funds are only up some 7% so far this year, according to Lipper, they're still beating the S&P 500 and investors have stuffed billions of dollars into them. In 1999, $33 billion flowed into tech funds. In the first five months of this year more than $36 billion has been invested in tech funds, according to Boston fund consultancy, Financial Research.

That's $69 billion in 17 months. Previously, the most money the category had ever taken in during any two calendar years was $6.6 billion in 1994 and 1995.

"The gambling mentality can take over with these things," says Ron Roge, a financial adviser based in Bohemia, N.Y. "It's going to be resolved by people losing money eventually."

The glut of new funds following hot performance and heavy inflows is a familiar pattern. More than 50 of the 97 real estate and financial services funds out there launched between 1996 and 1998 when those categories were hot. Since then, the categories' performance and cash flows have cooled and only five funds have launched since the start of 1999.

The amount of money surging into tech funds highlights the degree to which mutual fund investors have embraced sector funds. From 1990 to 1998, sector funds made up less than 5% of the total inflows to U.S. stock funds, according to Financial Research -- but last year, that number jumped to just under 20%. Through the end of May this year, sector funds' inflows have made up a whopping 44% of the flows into all U.S. stock funds.

Investors' soaring appetite for sector funds, and tech funds in particular, could entail significant risk. The average tech fund sports a 50.2 average price-to-earnings ratio, compared with 27.5 for the S&P 500, according to Baseline.

Also, several of the latest funds focus on subsectors like business-to-business e-commerce or tech stocks in Japan or India. Though many of these funds have a broader mandate than their name implies -- for example, Robert Turner says his B2B fund will hold the likes of General Electric(GE Quote) and Enron(ENE Quote) -- they still add up to a big risk for many investors. If you already own growth funds and add a tech fund, for instance, you're making a pronounced tech bet that could blow up if the sector heads into a prolonged blue period.

Tech has become a huge part of the major indices like the S&P 500 and the diversified funds judged by that benchmark. The average U.S. stock fund has more than 25% of its assets invested in technology, and large-cap growth funds -- a favorite among investors -- have a whopping 44.2% of their assets sunk into tech stocks, according to Morningstar.

(FDGRX Quote)Fidelity Growth Company, the top-selling diversified U.S. fund this year has a 46.6% tech stake. And 30 cents of every dollar invested in the steadfast (VFINX Quote)Vanguard 500 Index fund is in tech stocks, too.

Got Tech? Yes, Actually The average domestic stock fund's tech stake has been on the rise.
1995	1996	1997	1998	1999	2000
11%	15.4%	15.3%	17.7%	24.3%	25.8%
Source: Morningstar. Data through June 30.

"You do need tech exposure, but first you should look at how much you already have. If it's more than a third of your portfolio, you might want to scale it back," says Roge.

"The growth funds you have probably already own a lot of these same stocks the tech funds are buying," says Ferris.

Beyond the risk of compounding an already big tech bet, some say the gush of new funds has led several fund companies never known for picking tech stocks, like Neuberger Berman, Loomis Sayles and Delaware Funds, to jump into the game in order to stay competitive. And importing tech talent could be tough now that the gush of new funds and high-paying hedge funds have harvested the market.

"The talent pool question is critical. There's a lot of people that sit in fund managers' chairs and not all of them can produce," says Lipper chairman Mike Lipper.

Despite these risks and tech stocks' high valuations, the sector's rosy growth outlook should keep investor dollars flowing, leading to even more funds.

"The magnitude of the outperformance was so great that people are chasing performance and the fundamentals are so good that it's easy for people to talk themselves into committing more to the sector," says Morningstar senior analyst Scott Cooley.

But some say the glut of funds itself, which hasn't necessarily boosted tech stocks this year, could dim the sector's near-term outlook.

"I think it's a contrarian indicator when you get a huge increase in the number of funds focusing on a sector," says MaxFunds' Ferris. "It's almost always near the end of a hot cycle."