Janus Speaks: Q&A With Global Technology Manager Mike Lu

During Janus managers' year-end roundtable with reporters, Lu introduced himself and didn't say much else. Luckily he made some time to chat with TheStreet.com about the tech sector. Given his resume, you'll want to listen.

Janus Speaks!

Janus: Where It's Been, Where It's Headed

A Roundup From the Janus Conference.

A Q&A With Janus Global Technology's Mike Lu.

Meet the Family: A Look at Janus Offerings.

A Meet the Family Q&A With Janus Mercury's Warren Lammert.

Lu runs the shuttered Janus Global Technology fund, which rang up a 211% return in its first 12 months last year -- although the fund has retreated 25.6% so far this year. He's the don of tech-stock picking at Janus, advising his colleagues who put billions in the sector.

Lu likes "enablers," like software shops that help businesses transact on the Web. Tired of this year's rocky market, which seems steered by rumors more than fundamentals, he sees calmer times ahead where companies' fundamentals will be relevant again.

TSC: In 1999, the average tech fund posted a triple-digit return. What was your take on that once-in-a-generation market and where tech stocks are today, which is down?

Lu: Last year what I was telling people internally, especially when the markets looked really good, was, "Don't expect this kind of trend to continue." We didn't change our investment philosophy. On the technology side, as you know, we hardly invested in dot-coms at all. It was all in the "enablers." That's the same process we've been taking. If you look at a lot of the holdings, we've actually owned them for quite a few years.

There was no change in our approach and I was actually surprised by how well those enablers were realized in terms of market reward. Like anything where there's mass euphoria, the pendulum swings too far in one direction. In this case we've seen it swing a little too far with regard to valuation.

This year when the blow-ups occurred with some of the lower-quality names, whether in the infrastructure space or oftentimes in the dot-com space, the impact was felt throughout the entire tech arena. We're very fundamentally driven. So we've made our decisions on a stock-by-stock basis. But even though we deliberately did not invest in certain companies this year, when they missed their numbers the entire sub-segment they were in, and sometimes more broadly if they were some of the bellwether names, it affected the entire tech arena. So if you invested in tech you unfortunately got dragged down significantly.

The important thing is we haven't changed our approach, which is basically to go dig as deeply as we can and look at the fundamentals of these companies and try not to let the stock action distract us from our work. We're trying to find not only leaders but emerging leaders in different sub-segments. So you find me on the road doing research even more often this year. I'm not locked in front of my screen looking at the market activity, although sometimes the volatility is so extreme that you could potentially make some good trades.

You'll notice the turnover rate on my fund is pretty low and it remains low. Last year it was in the 30% range and this year it won't be above the 40% range.

TSC: Compared with your peers, who are often over 100%, meaning they're turning over their entire portfolio during the year.

Lu: Right, so I'm not doing a lot of trading. In this current situation I'm saying, let's double-check and triple-check and make sure we really believe in the fundamentals of the companies we own. That involves a lot of legwork and that's what we've been doing. When I first started seeing reports come out -- there's been a lot of rumors about us this year as you know.

TSC: The rumor that your fund was liquidating was a bit out of the blue.

Lu: You mean specifically the one about our fund? Oh, I was thinking more broadly than that. This year the market has been so driven by rumors and a lot of rumors about us in the last three or four months regarding Nokia(NOK Quote) -- that we're dumping Nokia. But as you can see from our reports, it's not us, but we don't typically comment on what we do. From that perspective our hands are a bit tied. But the main thing is that in our portfolio we intend to remain consistent in our thinking. We're planning to remain pretty low turnover and our top names remain at the top.

TSC: Clearly we were overdone on the upside last year and we may be overdone on the downside this year. As you said, it seems like one stock gets a cold and the rest of tech gets pneumonia. Where does that put us for next year?

Lu: I hope it will be more fundamentally based. It's hard for me to gauge where mass psychology is because that can turn on a dime, especially these days where information, good or bad, disseminates in nanoseconds. It's hard to gauge how and when psychology will turn.

But I do think in the longer run we will see people come back to fundamentals because that's ultimately what we have. With a lot of the tech valuations cut the way they have been, even for a lot of high-quality stocks and companies that continue to add value and gain market share in this kind of market, I think that in the longer run we will see the market react more positively to fundamentals and recognize that you can't throw the baby out with the bathwater. You have to distinguish between the companies you want to own with the kind of growth and consistency that you're after.

TSC: When we read about the market, people throw out mantras like, "Just buy the winners," as if it's easy to discern who the winners are. And as if there's that much growth left once we all know who they are. What are the criteria of a winner?

Lu: To that point about buying the leaders, people have to realize that in tech product cycles are extremely quick. So you can't rest on your laurels and say, Well, just because this company is in a leadership position today, it will be going forward. What you need is constant reinforcement in terms of the ability of the company to execute and identify the products and services that customers need. Ultimately I'm a very firm believer in talking to the customer base; that's why I'm on the road a lot. If what you have isn't what the customer needs, then no matter how good it is on a technology level, there is not going to be a market for it. And we all know the best technologies oftentimes don't win. It's all about having the right technology at the right time to satisfy what the customer's demands are.

TSC: Would an example of that be something like the Newton from Apple(AAPL Quote)? Now personal digital assistants, or PDAs, are huge and years ago Apple rolled out the Newton and no one cared.

Lu: Yes, it was a technology marvel when it came out. It had handwriting recognition that wasn't too far away from what I use now [unsheathes PDA] and I rely on mine almost exclusively these days to take notes. In the past four years I haven't taken any paper notes.

The problem with the Newton was there were enough mechanical and usability issues with it and the price point was too high. Plus it was a new market and people weren't quite sure what to do with it. So, yes, I think it's a great example from that perspective. It was one of these "gee whiz" type of products that might find a very small segment of early adopters who want to buy everything and try it out. But in terms of mass-market success, it wasn't there. It took something like the Palm that's actually a lot more restrictive, a lot more dedicated device that didn't have handwriting recognition to actually create this market. It had a well-defined and easy-to-use interface and set of functions that's easy for most people to use and people want to use it.

One of the things we always do religiously is make sure we don't just spin theories and say, "OK, optical [networking]. This is where everybody is going to go [to provide faster data communications]." We want to go to the users of the components and systems and try to think like the customers. Well, what do these specifications mean? What do these delivery timetables mean? How will this fit into the network? How will this affect the economics of my network? Go through those types of exercises and try to make decisions on those bases, based on what we know about what's happening in system and component vendors.

TSC: One other thing everybody touts now is secular growth. The economy is slowing down so everybody is looking for companies that are most insulated from the economy, using it as a type of moat around their castle. Once again, it's a simple idea that's actually pretty complex. What slices of tech stand out to you as having secular growth and what are some areas where that's not really there?

Lu: You're right, it's an easy mantra to chant. But the reality of practicing it is pretty complex. I don't really buy wholesale into the simplistic argument that there is any industry that is totally secularized or insulated from the ravages of the economy as a whole. I think the question is, "How critical are the products and services that you're offering? So that relative to other industries, your growth is faster."

We come back to the relative growth argument. What happens is that in the short term no matter how glowing the secular growth trend may be, you will get hit because as overall growth slows you may be growing faster than other industries but you're still slowing.

And in tech sometimes you see companies with explosive growth due to product cycles, but you can't continue to extrapolate that. You can't expect Cisco(CSCO Quote) or Sun Microsystems(SUNW Quote) to continue to grow at 60%-type growth because that's impossible. You have the law of large numbers, you have to think about that. But sometimes the market can be very shortsighted and punish companies. But to us, if we're satisfied with our research in what these companies can offer going forward, these can be opportunities.

One of the nice things about the market is you can have opportunities like that. From our point of view though, we still think it's best to invest in the enabler technologies, and in particular in the communications, optical-networking and wireless companies.

One area that's tougher to define is in the software arena. There are some specific software components that are needed to enable certain end-market developments.

TSC: There we're talking about business-to-business software shops that help companies transact on the Web. The Aribas(ARBA Quote) and i2 Technologies(ITWO Quote) of the world vs. Microsoft.

Lu: What's funny to me, and this might considered heresy, is I don't view a lot of dot-coms as tech companies. They're really not tech companies. They leverage technologies and use technologies, the Web in particular, but they're retailers or they're exchanges but they're not really tech companies per se. They use tech, but that's a distinction that often gets lost and I think that's one of the reasons why we didn't invest in a lot of these companies last year or this year. Because the business model, while positive because this is the direction you want a lot of companies to go, and the valuations and the hype around these companies were so intense that we just didn't feel comfortable.

TSC: Like Amazon.com(AMZN Quote) isn't a tech company. They sell books for a living.

Lu: Right, they're a retailer. They use the Web to do that. But what you want to see over time is other parts of the economy, other traditional retailers like Wal-Mart(WMT Quote) starting to do the same. But of course, they're starting from the bricks-and-mortars perspective because the vast majority of their sales are still location-based, not Web-based. But over time you want to see that kind of development create the productivity enhancements we're all hoping for.

Lu's Picks
Stock	Weighting in Janus Global Technology Fund
Sun Microsystems	4.7%
Nokia	4.6
JDS Uniphase	4.3
I2 Technologies	3.9
Veritas Software	3.7
Cisco Systems	3.3
Furukawa Electric Company	3.2
Texas Instruments	2.5
China Mobile	2.2
VeriSign	2.2
Source: Shareholder report. Holdings as of Oct. 31.

TSC: Let's look at some of the clouds people see over a group that people were really excited about: networkers. Instead of blue-skies with the endless buildout of communications networks, people are focusing on slowing spending on telecom equipment. Everybody has a different opinion; what's your take?

Lu: There are several degrees to these issues; there's layers. How much capital expenditure grows for a network operator depends on where they are in their network buildout, which dictates what type of equipment they're buying. So when you look at these broad-based surveys, so much is hidden within that. The data equipment vs. telephone equipment, for instance, and within that there are several layers.

So to generalize about how capital expenditure is slowing on a global basis doesn't really work. You have to look at it on a much more specific, case-by-case basis. For some companies, yes, their spending will decline, especially if their network is mostly built out. But if you look at it on a global basis, because it is a global market, you see equipment being utilized by the U.S. as well as internationally; we're still on a buildout phase. Even in the core part of the network there is still a lot to be done in Europe and Asia. And in metropolitan areas we're really only starting here in the U.S.

When it comes to access, that's just in its infancy. We're talking about a million or two million-type unit numbers. You're talking about the ramp that's still ahead of us and the equipment needed to support that. If you look at this type of spending, there's still so much to be done that I think a lot of the concerns today are being viewed in a very simplistic way and applied across the board.

TSC: We've all heard a lot about the Old Tech vs. New Tech battle. If you're tied to PC sales you're Old and if you're more tied to the Net's growth, you're New. One thing people have been saying is that the Old Tech stocks are on sale.

Lu: I think we need to look at that on a case-by-case basis because it's hard to generalize. Everybody is in a different product development curve. There are some so-called Old Tech companies that have very interesting PDA developments, for instance. Granted, they're a very small part of the business and don't have the mind share to go public. But they're developments that responsible longer-term investors have to watch. We can't just ignore them, we've got to watch them and see how they're doing and what kind of products they're coming out with. I wouldn't say all Old Tech is out, you've got to look at individual company developments.

The other thing is that it's hard to make a judgment strictly on valuation, too. Perhaps there's some reason why a stock is trading at a particular valuation level. Maybe they don't have the right people to take them to the next level. Or maybe they can't execute or maybe they have bad marketing or something. You just don't want to say that because it's trading at ten times next year's earnings it's an automatic buy.

TSC: In hindsight we miss everything. We misunderstand trends and fail to appreciate how powerful a new product will be. Is there something out there today that fits that bill? What's our biggest blind spot?

Lu: One thing that's interesting is that the awareness of technology and the benefits it can provide is so high right now because for the last couple of years tech has done so well as a group. So the interest level is extremely high. One thing that gets troubling is that you get early stage developments that get hyped significantly. Even something as solid as Java, for instance. When you look back to 1995 when it was actually rolled out that people were having unrealistic expectations: $100 million revenues in the first year of a programming language. If you think about that, yes Java has a significant impact over time, but are people were getting much too excited much too quickly.

I think we have to be more concerned about that aspect than not being aware of something. Right now with the Net the way it is, when new developments are coming out you get to see them quickly. The key issue is figuring out when a new development will actually start to help a company with its revenues, vs. the expectation levels for those things already.

One thing we were talking about last year and at the start of this year is that a lot of these companies were priced for perfection for the next couple of years and there's no room for error. And you know that's unsustainable because even the best companies miss-step or perception simply changes. That's something we have to continue to be vigilant about.

TSC: One think I noticed looking at your fund's shareholder report is that the fund's cash position is about 10%, which is a bit high. Is that a conscious decision to keep money on the sidelines?

Lu: Not really. Cash is always a by-product of looking for other opportunities. I don't set aside a fixed percentage for cash or a fixed percentage for international or European or Asian investments even though I think I have higher exposure overseas than my peers.

For instance, last year when the fund was really ramping up in cash flows, there were times when the fund was over 20% in cash. It wasn't a conscious decision, it's just that I don't want to throw money around and add something just to stay fully invested. I want to try to be careful and opportunistic as to when I should invest in companies because, especially this year where we've seen so much reaction to rumors, it has basically been a shoot-first, ask questions later atmosphere.

That presents a lot of opportunities, especially for companies we believe in. A good example of that is Nokia. People think we've been dumping and dumping. What happened? We ended up adding to our share count. Now a week after the analyst meeting it's being viewed by the talking heads on CNBC as the safe choice. How interesting.

It's those types of opportunities we like to take advantage of.

TSC: If there's similar DNA among the folks at the firm it's that they make big bets on stocks they like. But your fund is very diversified by comparison. You own around 100 stocks and your turnover is low. Why did you break the mold?

Lu: I think the portfolio management process just depends on the individual and how they like to shape the portfolio. From the outset I tried to design the portfolio as a diversified tech fund. It's not a closet semiconductor fund, or a closet dot-com portfolio. The charter is global technology and I try to live up to that. There are a lot of good companies in different parts of tech that deserve an investment in my opinion.

Also, personally I don't like to take huge, huge bets on individual names. Partly because I do view that technology is a fairly volatile area and I wanted to make sure that the fund stayed diversified and not get that risk profile so extreme that the investor is just shocked.

TSC: Right, a fund is not supposed to be a stock, but the more concentrated a fund is, the more like a stock it becomes.

Lu: Right it becomes sub-sector stocks. I tried to avoid that. Luckily in tech you do have enough good ideas. They might not be hitting at the right time, especially in this environment when everyone is so negative on technology. Again, our outlook is longer term and that's why you didn't see IPOs and short-term trading going on. You didn't see dot-coms either.

TSC: We've talked about the mantras out there. When some think of Janus funds they just focus on Janus funds' last two years and say they've had their time in the sun. We hear this from time to time, what's your response?

Lu: I don't know what else to say other than look at our longer-term record. Some of the funds don't have records beyond 1999, but when you look at where we've been invested in technology, we've owned a lot of these stocks for years. If you look at some of the stocks at the top of our portfolio, these are companies I was an analyst on before, names that popped up in our portfolios before the tech funds started.

Our approach is to try to identify companies early on. I guess I'd suggest people look back at our previous records and holdings. It's all there.