10 Questions With John Hancock Technology Fund's Marc Klee, Part 2

Be sure to read Part 1.

Klee: Intel(INTC) has not been a big favorite of ours.

It's finally come back down to a valuation level that we think makes it interesting. We're talking in the mid-20s, which is considerably lower than where it's been. Our biggest concern over the next couple of years is if they truly go out and spend the kinds of money they're talking about for capital expenditures, that not only is there a financial hitch because of the fact you spent the money -- either you borrowed it or you spent cash, so you lost the interest income -- but more importantly, it suggests building a lot of facilities and the need to very quickly to ramp up to utilize them, in other words, to get their costs down. That's a little disconcerting. So we're sort of neutral on Intel.

Oracle.

Klee: We severely reduced our position in Oracle(ORCL) earlier this year; stock's down about 60% since we did that. Our rationale for selling at the time was that it was not especially cheap. Like Microsoft, Oracle is not the fastest-growing technology company. It's a solid citizen, but it's not a rapid growth company. It's a mid-teens grower that was selling at around 60 times earnings, and that led us to scale back and sell most of our position.

Now the stock has gone and dropped by two-thirds since that point and once again, it's something that we think, in the coming months, we probably will be looking at again.

6. A lot of names we've talked about are the "old-tech" folks that are tied to the PC-server-client arena. But last year and in 1999, a lot of folks were really excited about "new tech," folks were more tied to the Internet. Among that pack, who stands out there as being the most intriguing today?

Klee: A lot of these stocks have gone and dropped to valuation levels where the term hat-sized can be used and in many cases, below that. The idea that stocks that sold at $150, $200, $250 a year ago can be picked up for, that you could buy a package of them for $10, is unbelievable.

We have never been big fans of a lot of the B2C, B2B type names. We thought that the business models really wouldn't hold, and even some of those have finally come down to valuation levels that we've started picking at those kinds of things for the first time, in some cases, ever.

And I'll give you one example of that: We own a small position now in Amazon(AMZN), which we have never owned since we bought in the IPO and never bought afterwards. We sold it a couple months after they went public and had never owned it until recently. It's a small position, admittedly, but we think it's kind of interesting now.

We have not been big believers in the B2B software, the Aribas(ARBA), the Commerce Ones(CMRC), the PurchasePros(PPRO). We've never owned those, we still don't.

But there are some software stocks on the other hand that we really think are interesting. i2(ITWO) in the supply-chain management space. BEA Systems(BEAS) in the middleware and the whole backbone software space. We think those kinds of companies that have been around a little bit longer than the last couple of years have been true beneficiaries of the Internet cycle, and we think some of them will continue to be big winners.

I like Veritas Software(VRTS). It's been a highflier that has come way down to earth as well, and I think storage is an inevitable beneficiary of the technology cycle. As more and more Internet usage gets done, it becomes cheaper to store, and there's a greater need and a greater desire to store than in previous incarnations. I'll give you one other name: Mercury Interactive(MERQ).

7. Last year, diversified growth funds as a group really ratcheted up their exposure to the tech sector -- to the point that many funds had more than half their money there. A lot of folks were surprised by how much they were hit when the Nasdaq fell and their supposedly diversified growth fund went down with it. Do you think that part of the pressure on the sector is these folks moving back out?

Klee: I think to a certain extent, that is indeed the case, since they have different places they can go. There are tech funds and there are tech funds. Even in the context of tech funds, some have broader charters than others. Some go to applied technology, some can do biotech, which we don't do. Because we have a healthcare fund and a biotech fund as well. So you do have different things, but obviously in growth funds, technology and, I guess, healthcare are the two sectors that tend to have the greatest focus, most of the time.

And I think you're right, I think what happened is, as you went through '98, late '98 and into '99, it became so apparent that technology was working. And very little else did. I think people lost sight of that. From the bottom of '98 until March 2000, this period where the tech stocks did well, the broad market itself actually declined.

Look at '99 where the Nasdaq was up 86%, and almost half the stocks in the stocks in the Nasdaq were down, which tells you it was somewhat narrow.

To be up 85.5%, clearly the winners had to win big time, and that was tech. And I think for broad-based growth managers, they clearly did gravitate towards technology because the growth was there and the stocks were working. And if you didn't hop on board, you badly lagged. And, I think it's very difficult to watch something happening and not participate. You have to have a lot of courage of your convictions.

I think what happened is, as something works, there's a tendency to follow it, but also, remember what else happens. If you have a portfolio with a hundred dollars in it, and if you had half of it in technology, and that doubled and the other half did nothing, all of a sudden, the end of a year, you have $150.00 but you've gone from 50% technology to 2/3 technology, because the market carried you there. So I think that was part of it as well. In some cases you probably had people who were selling technology but still, you had a huge weighting.

Klee: Exactly. And because of the appreciation. I think you're seeing some of that unwinding, and you have been for the last few months, and it's picked up steam, which is, again, sort of a natural kind of thing historically. Every market goes through three phases. They're known as the three "Cs" -- the first phase is complacency. And that's where a stock goes from 100 to 70 or whatever and the natural tendency is to go, "Wow! What a bargain! I never thought I'd see this stock so cheap."

Then the stock goes to 40, and the natural thought is, you know, when it gets to 55 I'll take a small loss and move on. That's the concerned phase, because there's no "if" in the thought process.

And, finally, you come to the capitulation phase, which is, The stock's down to 20 -- get me out!"

Now I think that's more of a problem for the individual investor than it is for the institutional investor, where they're doing this full-time and they know what's going on, and are watching it.

But I think a lot of people get caught up in the emotion of it go through those three "Cs" and I think what you're seeing now is that capitulation phase where the volume is getting heavy and deeper and people are saying just get me out of these things. And that's why I think we're coming to the end of the cycle here.

8. Fund flows follow performance but with a pretty significant lag, usually. Now we're starting to see net redemptions from technology and aggressive growth funds -- the hardest-hit areas. And some people would say that those redemptions, if they persist for six, nine, or 12 months, can put further pressure on a battered sector. What's your thought there?

Klee: I have mixed emotions about that. I think obviously there's some validity to that, but I also think it gets overstated. I think if you look at the total value of the assets in, let's say, technology sector funds and you aggregate them, together they probably make up less in assets than certainly the top one or two growth funds. So in the scheme of things, they're not that important.

But if you start to see it out of the big growth funds, too, then the question becomes does that happen, and in today's system where, with 401(k) money and regular divestments and all, while you are likely to see significant redemptions over a period of time out of the more aggressive funds -- and I think if you look at some of the Internet funds, there's no question that you get redemptions -- that's not as big a deal as I think it's sometimes made out to be. That's because it doesn't take into account individual and direct investments, it doesn't take into account pension plans and things like that.

The other thing that happens is you also get a change in ownership, and I think that gets pooh-poohed a little bit, because it's not as obvious. But when you get down to these kinds of environments, you get value buyers taking a look. I don't know if you know the name Tim Quinlisk. He runs our value funds at Hancock, and Tim is a relative value buyer. And he is the classic investor who would look at some of these opportunities in the technology sector and say, some of these things have just gotten out of hand.

I also think there's another source of buying that hasn't been talked about much and that's repurchases by companies. In the past few weeks, talking the tech space now, we've had companies like Nokia, Cypress Semiconductor, Applied Materials, Yahoo, Sun and Cisco --companies in different sectors -- all announce large share repurchases. Well that takes some of that out as well. So I think when you start to look at that supply/demand for funds, there's too many cross currents to feel really comfortable making a conclusion.

I'm not saying you're wrong, it's just that I'm not good at isolating out one part vs. another, because there are just too many cross currents here.

9. When we talk about pre-announcements, it's obvious that's been happening quite a bit. Do you think more are in the offing?

Klee: I think it's inevitable because the problem is, this, to a certain extent, is done in a hockey stick manner, meaning that the third month of the quarter is relatively more important than the first two months. It's very typical of a company to do 40%, 50%, or 60% of their quarter's revenues in the third month of the quarter, and therefore, a lot of times companies come down near the end of the quarter, let's say with a couple weeks to go, and they don't know whether or not they're going to make the numbers because they're waiting for a couple of large orders to close.

And if they don't, which in this environment, which is one of great caution, there's a reasonable likelihood they don't close. So that's what causes that.

10. Last question. If you had to pick three stocks to buy and hold for five years -- without selling in and out of them -- what would they be and why?

Klee: The first would be AOL/Time Warner(AOL). I think that they are going to emerge as a media powerhouse, and given the five-year time frame, I think financials become critical as one looks at the environment.

I think you're going to see tremendous cash-flow generation come out of AOL over time. I think they have a very dominant mind share amongst the public in terms of usage of the products, whether it be the AOL service or be one of the variety of Time magazines or HBO or CNN, and I think that media will continue to evolve over time, but I think it's inevitable that they will continue to be a leader. So I would pick that.

Second name I would pick would be EMC(EMC). The stock obviously has been under traumatic pressure. As we speak today, the stock's around $26. Much of their decline came a little bit later than some of the others. I was mentioning earlier my belief that storage is inevitably going to grow.

I refer to storage as an area of insatiable demand, and I think that EMC, while not necessarily going to be as dominant five years from now as they are today, or having the pricing flexibility that they do today, I think still has a reasonable likelihood of being a or possibly the dominant player in that space.

The third name that I would pick would be BEA Systems(BEAS). Admittedly, a lesser-known name and maybe a little more aggressive, but I think BEA has become the platform of choice for a lot of software development, even though I expect them to be in a very competitive environment over the coming years.

I think given the kind of environment we're in today, the likelihood is that some of their potential competition may very well go by the wayside, not necessarily going out of business, although that may happen, but certainly not being able to get the financial wherewithal to really grow and get a foothold over the coming couple of years, which I think will give BEA even a more dominant position.

Long term, I worry about companies like Oracle and potentially Siebel and Microsoft and other software companies that all sort of merge towards the middle. Even companies like Sun could become a player in that, but I think BEA has really established itself and can be very dominant in a number of software niches.

Be sure to read Part 1.

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