Without a Net: The Perilous State of Internet Funds

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Thanks to their mercurial performances and glaring instability, Net funds earn comparisons with Robert Downey Jr. and merit our attention as a cautionary tale of excess.

At the start of 1999, there were just four Net funds and most fund company executives scoffed at them as too narrowly focused and aggressive. Then those four funds averaged gains of more than 200% that year, triggering a glut of investors' cash and new Net funds in 2000. Of course, all of those performance-chasing greenbacks and funds showed up just in time to absorb a drubbing of historic proportions, as TheStreet.com's Internet Sector index lost nearly three-quarters of its value last year.

Hardly Dot-Calm Owning Net stocks or funds has felt a lot like riding a tiger over the past couple of years
	TheStreet.com Internet Sector Index	S&P 500
YTD Return	0.5%	-0.6%
2000 Return	-73.4	-9.1
1999 Return	184	21.0
Source: Baseline/Thomson Financial. Returns through May 21.

Even after a bonny April, cash-starved and market-battered Net funds are looking like an endangered species. Seems every day another Net fund merges into a broader tech portfolio, morphs into a different type of fund or just throws in the towel.

"The state of this pack is clearly troubled," says Chris Traulsen, a fund analyst with Chicago-based fund tracker Morningstar. "A lot of fund companies are under pressure to make these [Net] funds profitable or close them."

While it's hard to say that the Internet isn't going to keep blooming and affecting business, it's even harder to make the case for owning shares of these too-focused and often pricey funds. Today the Big Screen looks at how hard Net funds have been hit, why they're not a great investment and how they're defining Net stocks these days.

Today, there are some 30 Net funds out there, and they're down a whopping 40% on average over the past year, compared with an 8.7% loss for the S&P 500 , according to Morningstar. On average, they also sport annual expenses above the tech-fund category's already high 1.78% average and are less than two years old.

Thumped The some 30 Net funds out there are down more than 40% on average over the past year
Net Fund	YTD Return	1-Year Return
(WWWEX Quote)Kinetics Internet Emerging Growth	8.7%	-40.9%
(STECX Quote)STI Classic E-Commerce	4.5	-2.1
(WWWFX Quote)Kinetics Internet	4.2	-25.6
(RIAFX Quote)RS Internet Age	-0.6	-30.1
(EIFAX Quote)Enterprise Internet	-3.0	-36.3
(WWWIX Quote)Kinetics Internet Infrastructure	-5.0	-36.5
(GITAX Quote)Goldman Sachs Internet Tollkeeper	-5.6	-28.3
(WWWGX Quote)Kinetics Internet Global Growth	-7.5	-31.0
(ETECX Quote)E*Trade E-Commerce Index	-10.7	-36.7
(PDISX Quote)Potomac Internet/Short	-13.2	44.3
(RYIAX Quote)Rydex Internet	-14.6	-59.8
(TBTBX Quote)Turner B2B Internet E-Commerce	-15.4	N/A
(EIIAX Quote)Enterprise International Internet	-17.6	N/A
(IINTX Quote)Investec internet.com Index	-20.4	-56.2
(MNNAX Quote)Munder NetNet	-20.9	-52.8
(MNIAX Quote)Munder International NetNet	-21.4	-53.1
(INGAX Quote)Pilgrim Internet	-24.1	-63.1
(MANTX Quote)Merrill Lynch Internet Strategies*	-25.6	-49.2
(JAMFX Quote)Jacob Internet	-26.1	-71.3
(ATCHX Quote)Amerindo Technology	-27.7	-59.0
(SNETX Quote)Strong Internet*	-27.8	-49.8
(STNAX Quote)SunAmerica Focus TechNet	-28.7	N/A
Investors Capital Internet	-30.4	-62.7
(TEFQX Quote)Firsthand e-Commerce	-36.7	-63.7
(INPIX Quote)Internet Ultra Sector	-44.6	N/A
(BTBAX Quote)Amerindo Internet B2B	-45.1	N/A
(INPSX Quote)ProFunds Internet	-45.6	N/A
Avg. Net fund	-17.9	-40.8
Avg. Tech fund	-15.3	-36.5
S&P 500	-0.6	-8.7
Source: Morningstar and MaxFunds.com. Returns through May 21. *Funds are slated to merge into broader tech funds

It might be natural to assume that these funds' sagging returns over the past year are outweighed by earlier gains for the relatively few investors who bought shares before 1999's frothy gains. But that's not necessarily true.

The biggest kid on the Net-fund block out there is the $2.4 billion broker-sold (MNNAX Quote)Munder NetNet fund, which opens to new investors Wednesday after closing in April 2000 with about $12 billion in its coffers. A look at some hypothetical investments in this fund shows that it hasn't been easy for investors to make money unless they're among the few who bought shares back in 1997 or 1998.

A $10,000 investment in the fund at the start of last year, when a glut of money followed the fund's 175.7% gain in 1999, would've been worth just $3,097.44 on May 1 of this year, according to Morningstar. In fact, thanks to the fund's 52.8% loss over the past 12 months, the same investment on Jan. 1, 1999, would also be underwater and worth only about $8,500 on May 1.

Diminishing Returns Most of the money that gushed into Net funds showed up after the 1998 and 1999 boom. A look at hypothetical investments in the Munder NetNet fund shows that even an investment at the start of 1999 would be underwater now
A $10,000 investment in Munder NetNet on...	... Would've been worth
Jan. 1, 1997	$21,911.35
Jan. 1, 1998	16,879.54
Jan. 1, 1999	8,536.79
Jan. 1, 2000	3,097.44
Jan. 1, 2001	6,767.10
Source: Morningstar. Returns through May 1.

The silver lining is that some Net funds have found a way to sidestep some of the dot-com carnage. The (WWWFX Quote)Kinetics Internet fund, one of the first four Net funds launched, is one of just three Net funds to be in the black since Jan. 1. But funds that show up on top-10 scoreboards often get there by doing something quite different, often leaving shareholders with a different portfolio than they expected.

For instance, this fund had more than 20% of its money in cash at the end of the first quarter and almost 17% of its assets in pharmaceutical data research shop IMS Health (RX Quote). Kinetics is up more than 7% so far this year and in the black by 98% over the past 12 months, according to Morningstar. Most funds typically keep their cash levels around 5% and their individual stock positions there or lower.

Kinetics isn't the only fund broadening its menu beyond pure plays like Amazon.com or Yahoo!. If we toss the five biggest Net fund's portfolios into a pot and sift out their cumulative top-10 holdings, we find IMS Health, graphic design software shop MarcoMedia(MACR Quote) and cable TV concern AT&T Liberty Media(LMG.A Quote).

Net Stocks If we toss the five biggest Net funds' portfolios into a pot and sift out their cumulative top-10, we find a dearth of traditional Net bellwethers
Stock	Percentage of Combined Portfolio	1-Year Return
IMS Health(RX Quote)	4.0%	98.1%
Ariba(ARBA Quote)	4.0	-88.6
eBay(EBAY Quote)	2.7	-6.0
Oracle(ORCL Quote)	2.5	-46.6
Verisign(VRSN Quote)	2.3	-42.6
BEA Systems(BEAS Quote)	2.3	21.7
AT&T Liberty Media(LMG.A Quote)	2.3	-11.3
MacroMedia(MACR Quote)	2.1	-67.7
Siebel Systems(SEBL Quote)	2.0	-2.9
Interwoven(IWOV Quote)	1.7	39.4
Source: Morningstar. Holdings through funds' most recent portfolio report.

Oddly enough, drastic but successful moves like these might weaken the argument for owning Net funds. The idea here is that if companies like brokerage titan Merrill Lynch (MER Quote) and discount-retailing giant Wal-Mart(WMT Quote) are Net plays -- and these companies shares have turned up in Net funds -- it might make more sense to own a broader growth fund, which might have lower expenses and a more tenured manager.

"Managers are clearly taking a broad definition of a Net stock. But if that's the case, why buy a newer, smaller fund?" asks Morningstar's Traulsen after looking at Kinetics' portfolio. "Part of the issue facing these funds, beyond their terrible performance, is that as the Internet grows up and becomes part of what many companies do, there's less and less distinguishing these funds from other tech funds, media funds or growth funds."

It seems that investors might be agreeing. The average Net fund has about $100 million in assets, less than a quarter that of the average tech fund, according to Morningstar. In fact, about one-third of Net funds have less than $15 million in assets. Industry veterans say the break-even point for most funds is at about $50 million, depending on a fund's expenses.

Thanks to these economic realities, fund companies are starting to scuttle their Net funds. Over the past 12 months, the deLeon Internet 100, Internet Index, StockJungle.com Pure Play Internet and Zero Gravity Internet funds have all liquidated. This year the (MANTX Quote)Merrill Lynch Internet Strategies fund and the (SNETX Quote)Strong Internet fund will both ask shareholders to approve merging into a broader tech fund.

Meanwhile, the (NETAX Quote)Westcott Nothing But Net fund has morphed into the broader Westcott Technology fund. And over the past 18 months, the (MFITX Quote)Monument Internet fund, 1999's top Net performer with a 273% gain, has lost its manager, changed its name to the Monument Digital Technology fund, and now the folks at Monument plan to make it part of the Orbitex fund group, pending shareholder approval.

The bottom line: Net funds are going through puberty, trying to survive their current blue period by essentially modeling themselves on broader tech and growth funds. In that case, it's hard to see why there's any reason to own a "Net fund" anymore. Check out these past columns for a look at some of the better growth and tech funds out there.