10 Questions With IPS Millennium Fund Manager Robert Loest

Lots of fund managers can talk tech stocks these days, but IPS Funds' Robert Loest is cut from a different cloth.

Beyond those outsize gains his (IPSMX)IPS Millennium has racked up, he has let it all hang out in an industry that keeps its cards close to its vest. Instead of guarding his moves, he keeps a running online diary for his investors where he tells what he's buying and selling, admitting his mistakes along the way in plain talk.

An evangelist for the "connectivity" investment theme that includes companies that make tiny chips and those that pump out miles of cutting edge fiber-optic cable, he also sees opportunities in electric utilities. He likes some tech companies you've probably never heard of, and he's down on household names such as Microsoft and AT&T. And he's developing a fund where the shareholders will call the shots.

Robert Loest
Fund (IPSMX)IPS Millennium
Managing Fund Since Jan. 3, 1995 (inception)
Assets $510 million
1-Year Return / Rank in Category 73.1% / 2 of 697
5-Year Annualized Return/Rank in Category 39.1% / 1 of 251
Load / Expense Ratio None / 1.39%
Top Holdings Calpine (CPN) JDS Uniphase (JDSU) Broadcom (BRCM)
Source: Lipper. Performance through Aug. 17. Holdings as of Aug. 14.

1. What sectors and stocks look good to you right now?

Loest: I like optical networking. The two names I like right now: ONI Systems(ONIS) and Avanex(AVNX). Another sector I like is color flat-panel displays for portable devices and desktop screens as well. The names that jump out at me there are Kopin(KOPN) and Cree(CREE).

We're headed towards a very highly connected civilization, and these optical-networking stocks are increasing bandwidth and connectivity. The companies that make the components for these portable connected devices are the ones that are going to be big winners. Kopin and Cree and others make a lot of the components of the displays that we're going to be using to access the Internet.

2. What sectors do you see as overvalued right now, and how do you go about valuing companies in pricey sectors?

Loest: Electric utilities have had a pretty good run; I'd hold off on those until the sector pulled back. I'm hard-put to find sectors that I invest in that are really overvalued, simply because Nasdaq's still not much off its bottom. I mean there's not a whole lot out there that I consider overvalued.

In the areas I invest in, I just try to see whether or not the sector or these individual stocks are near a high. These companies are really volatile, and if you look at the most recent 12-month high, you can just bet the rent money that sometime in the next nine or 10 months, they're going to drop at least 30%, and very often, 50% or more.

This last drop was extreme, but this has happened at least once a year every year since 1995. We don't have the metrics that we need to say, "OK, this is fair value," like you do for a mature industrial company. We really don't know what fair value is on them.

You have to employ an empirical measure, which is, in my case, simply a relative price measure. Where is it selling relative to its most recent high? And if it's well down from that, I'll buy it, assuming nothing else has changed, assuming that it's still growing the top line of sales rapidly and that it's still the dominant company in its sector.

There are three things we look at: very rapid and accelerating top-line growth, whether the company is going to be a dominant player, and the price needs to be well down from its high.

3. In looking at the portfolio from July 31, I noticed that there are a lot of utilities shops -- Peco Energy(PE), AES(AES), Calpine(CPN), Duke Energy(DUK). What are you seeing in the utility sector?

Loest: We are entering the early stages of a power shortage in this country that is going to go on for a decade. And it's going to become very severe, simply because the digital economy now is not ramping off a tiny base, it's 13% of GDP , if you go by the well-publicized figures. And it's growing at a huge rate. It consumes far more power than the industrial part of the economy.

A really large server farm can consume the output of a small nuclear power plant. These things are dramatically accelerating the growth curve of energy demand in this country, and both the government and the electric utility industry have discouraged the building of new plants for 15 or 20 years, because we were in a slowing, mature, industrial economy where power demand had slowed down.

And suddenly that's reversed and started back up again, so we're caught in a situation where even if we recognize fully the situation today and start building more power plants as fast as we can, it'll probably be a decade before we catch up. And what's going to happen here is that the losers are going to be the electric utilities that don't have enough generator capacity and have to buy during peak demand periods from other utilities.

And you've seen from price spikes that this can be ruinous, financially. The winners are going to be the companies like Calpine that are building the new generating capacity, with these super-high efficiency combined cyclo-gas turbine, and companies like Enron(ENE) and Dynegy(DYN) or NRG(NRG) that are trading energy and companies that have excess generating capacity.

4. The recent New Economy merger deal between Phone.com(PHCM) and Software.com(SWCM) gave a big boost to both stocks. In May you had big positions in both companies, but you got out of Phone.com before the deal was announced. Are you happy with your moves, and what do you see ahead for the combined company?

Loest: Given what we knew at the time, I'm happy I did what I did. I sort of wish I hadn't, but it doesn't really matter, I mean we're going to get Phone.com back, obviously, since we still own a lot of Software.com.

Phone.com's product is obsolete already, simply because Kopin and a couple of other companies are manufacturing these micro-mini displays that you can clip on your glasses. Which is why we sold Phone.com, but what they've done to try to survive, and I think it's a smart move, is to buy Software.com, because Software.com supplies the mailboxes and a lot of other software for enterprises.

Their old product is something that they won't be using with the service companies much longer. What they've done is they've bought a new product they can use with all of the wireless service companies. So it's a way for them to survive, and it's a way to add, to increase the potential market for Software.com's products.

You saw the sense of this deal from the market's reaction. The stock shot way the hell up. Any time you have a really good synergy in a merger, both companies go up.

5. What's your take on Microsoft(MSFT) and Cisco(CSCO) these days?

Loest: We sold all of our Microsoft recently. And the reason is, it behaves more and more like a mature company in a mature phase of its business cycle. And it's simply not growing fast enough and doesn't have the kind of enormous future market potential that I'm looking for. It's already realized its enormous future market potential.

Microsoft's getting in a lot of new areas, but they're no longer the gorilla in those areas, and they're very often the second-, or third- or fourth-tier player.

Cisco is a beneficiary of a dramatic shift from companies like Lucent(LU) and Nortel(NT), which are standardized on voice communications, to the move towards a data-centric system in our communications system.

And while they're smaller, they are clearly in the sweet spot of where connectivity is moving, which is towards the data-centric systems. And I think, on the one hand, they're up against a couple of titans, so they lack something in terms of sheer mass, but on the other hand, they're playing the ball game in their own back yard, and I think Cisco has still a lot of growth ahead of it.

I think it's going to slow because they seem to have missed the curve in the switch to optical network. Not so much missed it; it's changed so fast that Cisco's having a hard time keeping up in terms of acquisitions. They are trying to move from switching and routing for the enterprise to the big service providers, where they're not as dominant, and they are getting a lot more competition from the likes of Sycamore(SCMR) and Juniper(JNPR).

They also are up against a total attack on what they do, which is switching electrons to switching photons. And they're not nearly as good at that, so I think there's a little doubt about how well they're going to compete in this new marketplace as it grows. But on the other hand, I think I'd probably rather own them than Lucent, and maybe even Nortel.

6. A growing number of funds, in varying degrees, are giving their shareholders access to stock picking and decision making. Your group is developing the iFund, where investors will have some say in what stocks the fund will own. What's driving this trend and what are your thoughts on the issue?

Loest: They won't have some say, they'll run the whole thing, lock, stock and barrel.

This is an idea, which, to me, looks like its time has clearly come. The Internet is fully connected, and we have a large enough mass of users, that they are starting to do their investing this way in fairly large numbers. You also have an enormous interest on the part of individuals to do their own investing with a group of people, which is why you have millions of investment club members all over the U.S.

This basically is going to work like an investment club, only on a much larger scale, with a far higher degree of connectivity. Instead of meeting once a month, they're going to meet perpetually over the Internet and have access to far more research and have a far better organized structure for making decisions about buying and selling stocks. The theory behind this is simply the theory behind complex adaptor systems theory, which is that when you connect enough people, continuously and in broadband with unlimited feedback, you get what's known as emergent behaviors. The stock market is typical of that. You connect enough people, you get something that tends to function at a higher level and reflect a level of intelligence and knowledge far beyond that of an individual.

And the fund is based on the premise that this can work on a smaller level with enough committed individuals, and we figure somewhere below 1000 investors we'll hit critical mass.

7. What was your best decision in this year's first half, and what was a decision where you may have misstepped?

Loest: The best decision was to dramatically increase our exposure to electric utilities and alternative-energy equipment makers. Probably the worst idea was B2B software. We made a huge amount of money in it last year, but it crashed harder than anything else this year. And in a general sense, the worst mistake was probably an overemphasis on software as opposed to equipment companies.

I thought they we were further ahead in our progress towards connectivity than we were and that the software companies would start adding major value, but clearly, as we switch more and more to optical networking and some of these other breakthroughs like Bluetooth and small flat-panel displays drive technology, we just keep ramping to higher and higher technologies, so what we've done is scale back our exposure to software and buy a lot more hardware component manufacturers and companies like that instead.

8. There has been some debate about AT&T(T) in terms of an old-line company that is trying to shift gears and head in New Economy directions. What do you think of the company as an investment?

Loest: Bad idea. Bad, bad, bad. Stay the hell away from AT&T. They are encumbered by a worse-than-normal bureaucracy that's sclerotic as hell. [Chief Executive C. Michael] Armstrong talks a good game, but he doesn't actually do it.

The other thing is, they're still highly dependent on long-distance voice revenue, and the income from those has fallen dramatically. It's probably going to be free in another year or two, and finally, they're using an obsolete technology, which is time division multiplexing (TDMA) instead of switching to CDMA [Code-Division Multiple Access, an encoding system], or GSM [Global System for Mobile Communications, a rival encoding system], so they refuse to recognize a fundamental technological shift in industry that's far superior to what they came up with.

And they're just a big, old, slow-growth company that doesn't have an Internet gear. And I'm sure Armstrong understands what's going on, but that's not good enough. You not only have to understand what's going on, you have to act on that understanding at the speed Internet companies act on it, not at the speed old regulated bureaucracies act on it. They haven't made that shift, and I don't think they're capable of it.

9. If you had to pick three stocks and hold them for five years, what would they be?

Loest: I don't think you can do that any more. Do I have to pick some anyway?

What if we said three for a year?

Loest: I'd probably take Kopin, Network Appliance(NTAP) and Calpine.

10. What was the last new stock you added to your fund, and the last new name you added to your personal portfolio?

Loest: We're not allowed to trade stock individually. The last new name I added for the fund, I think, is Storage Networks(STOR).

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