Net Fund's Collapse Highlights Dangers of Chasing Hot Sectors

The top Internet fund from 1999 is writing the latest chapter in the staggering Net pack's tale of woe.

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Monument Funds is drafting a proxy asking shareholders of the (MFITX Quote)Digital Technology fund -- formerly known as the Monument Internet fund -- and two other struggling sector funds to approve handing the small and battered trio over to the Orbitex Group, according to a Wednesday press release. If shareholders OK the move, Monument's Digital Technology, (MFMAX Quote)Medical Sciences and (MFTAX Quote)Telecommunications funds will all be run by Orbitex managers and the funds will become part of the Orbitex fund lineup. This would appear to leave Monument with just its (ENETX Quote)EuroNet and Genomics funds.

For investors, the situation highlights the risks of investing in sector and subsector funds, particularly those launched in droves on the heels of fat returns by fledgling shops that might be more motivated by a fund's popularity than its long-term viability. It also provides a blueprint for moves that may become increasingly familiar as small, ravaged funds focusing on sector slivers like Net or genomics stocks find themselves painted into a nasty corner of the market.

"With niche funds, they're often focusing on the trendiest spaces and these are the kinds of funds that look outdated very fast," says Russ Kinnel, director of fund research at Chicago-based Morningstar. "I think a lot of these smaller, Net-focused managers are going to have a rough go of it for a while."

Riding the Wave

At the beginning of 1999 there were just four Net funds, including Monument's, and now there are nearly 30. While the funds made marketers salivate, many were launched into the teeth of the Nasdaq's collapse. TheStreet.com's Internet Index is down 79.7% since the Nasdaq peaked on March 10, 2000. And Net faves like Yahoo!(YHOO Quote) and Amazon.com(AMZN Quote) are down 85.1% and 74.8%, respectively, over the past 12 months, according to Baseline/Thomson Financial.

While this is just the latest example of a once-hot Net fund either disappearing or undergoing serious surgery in hopes of surviving the dot-com bubble's painful burst, the Digital Technology fund's past success puts the group's reversal of fortune in stark relief. In 1999, the fund topped all its Net peers with a 273% gain. Since then it has lost manager Alex Cheung, changed its name to fit a broadened focus and tumbled more than 65%.

The other two sector funds Monument hopes to hand over to Orbitex haven't thrived lately, either. The Medical Sciences and Telecommunications funds are down 12.6% and 48.9%, respectively, over the past 12 months and both are trailing more than 65% of their peers, according to Morningstar.

Before this move, Monument's chief investment officer ran the Digital Technology and Telecommunications funds. Alidad Mireskandari has steered the Medical Sciences fund.

A Monument spokeswoman didn't return a call for comment, but the funds' sagging returns are no doubt making them a losing proposition for the company, making it tough to maintain a full cadre of analysts. Industry veterans say most funds break even at around $100 million and the three funds' combined assets are about $85 million. The average technology sector fund has some $425 million in assets, according to Morningstar.

Pending shareholder approval, Glenn Frey, manager of the (OITAX Quote)Orbitex Info-Tech & Communications fund, will take over the Digital Technology and Communications funds. The Medical Sciences fund will have Timothy Bepler, manager of the (ORHAX Quote)Orbitex Health & Biotechnology fund, at the helm.

Unfortunately, this might not be good news for the Monument funds' few remaining shareholders. Not only are their funds shifting gears, but both Frey's and Bepler's funds have been harder hit than their peers, trailing at least 75% of their competitors over the past year, according to Morningstar.

Going From Bad to Worse? The performance of three of Monument's funds and their proposed merger partners
Fund	YTD Return	2000 Return	1999 Return
(MFITX Quote)Monument Digital Technology	-20.4%	-56.9%	273.1%
(OITAX Quote)Orbitex Info-Tech & Communications	-26.8	-36.7	167.9
Avg. Tech fund	-21.4	-33	136
(MFMAX Quote)Monument Medical Sciences	-18.9%	34.1%	75.8%
(ORHAX Quote)Orbitex Health & Biotechnology	-18	56.2	N/A
Avg. Health fund	-14.4	55.4	19.6
(MFTAX Quote)Monument Telecommunications	-14.8%	-36.7%	109.6%
Avg. Communications fund	-14.6	-32.1	68.3
Source: Morningstar. Returns through May 16.

Lessons of the Fall

While these funds' travails are extreme, they aren't necessarily surprising. Fund companies have launched record numbers of new tech, telecom and health funds over the past three years, hoping to capitalize on lofty gains and inflows. This leads to the classic criticism of fund companies for launching funds focused on hot sectors in which they have little experience, simply because they are selling at the moment.

As we've noted in the past, a gush of new funds focusing on a given sector often presages a tumble for that corner of the market.

"The history of sector-fund rollouts is that it's a real contrarian indicator. When a lot of sector funds show up, you've got to be wary," says Morningstar's Kinnel. "It calls into question [fund companies'] expertise and motivation. If they're just putting their finger to the wind and looking at what's selling, that's not good."

While Monument's Net fund makes it a fitting poster child for this sector-fund malaise due to its heady 1999 gains, it's hardly alone. The average Net fund lost more than half its value last year and is down another 24% through the first four months of this year, according to Morningstar.

Caught in the Net
	YTD through May 1	2000	1999
Avg. Net fund	-24.1%	-53.8%	216.2%
S&P 500	-5	-9.1	21
Avg. Tech fund	-21.7	-33	136
Source: Morningstar.

Thanks to these horrific losses, fund companies are starting to sweep their Net funds under the carpet. Over the past year the deLeon Internet 100, Internet Index, StockJungle.com Pure Play Internet and Zero Gravity Internet funds have all thrown in the towel and cashed out their investors. More recently, the Merrill Lynch Internet Strategies fund and the Strong Internet fund are planning to ask their shareholders to approve mergers into broader tech funds.

The Hit List Over the past year, several Net funds have either faded into the ether or been folded into other tech funds. Now 29 are left
Zero Gravity Internet	Liquidated
StockJungle.com Pure Play Internet	Liquidated
Internet Index	Liquidated
deLeon Internet 100	Liquidated
Merrill Internet Strategies	Proposed Merger into Merrill Lynch Global Technology
Strong Internet	Proposed Merger into Strong Technology 100
Source: Morningstar and FreeEdgar.com

And this trend might not end anytime soon. Ten of the some 30 Net funds left have less than $20 million in assets, according to Morningstar. That list includes the three Net funds offered by Kinetics Asset Management. Kinetics actually offers five funds with "Internet" labels, including its Internet fund, which has weathered the past year's storm better than most tech funds, losing 35.4%.

The takeaway from the collapse of Net funds appears clear: Funds, fund companies and fund investors who bet the farm on a sector or sliver of one sector are setting themselves up for a nasty fall.