Tech Slaughter Bleeds Sector Funds Dry

Like a daredevil in a body cast, fund investors are reluctant to make the sector leap again.

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Record billions gushed into sector funds, mainly once-hot tech funds, in each of the past two years. But following last year's collapse of the Nasdaq Composite bubble, nearly every sector-fund category is under water, led by the average tech fund's stunning 55% loss. So this year the sector funds cash spigot has abruptly run dry, with more money flowing out than coming in.

The reason: Breathtaking losses have left battered investors favoring diversification over a skewed portfolio whose fate rides on the success of one mercurial group.

"Sector funds as a whole have suddenly become too hot to handle for a subset of investors," says Jim Lowell, editor of the independent newsletter FidelityInvestor.com. "They were probably those who were most aggressive and thus most vulnerable to the selloff."

How Many Yachts?

Most candy-colored asset allocation pies in fund marketing brochures suggest investors limit their sector-fund holdings to 10% of the portfolio. But when the tech sector went on its unprecedented run, investors got a bit greedy.

Sector funds didn't account for more than a dime of every buck invested in U.S. stock funds in any year from 1990 through 1998. But in 1999 the average tech fund rang up a 136% return, triggering a two-year flood of money: Sector funds accounted for more than 20% of the money that went into stock funds in 1999 and a stunning 33% last year, according to Boston fund consultancy Financial Research Corp.

In the first half of this year, however, redemptions from sector funds have outpaced investments by $3.4 billion. That adds up to just 1.8% of the focused funds' assets. But consider that in the same period last year they took in more than $52 billion.

Thanks but No Thanks Sector funds losing their shine

Source: Financial Research. Data as of June 30.

"I think a lot of people definitely got burned and the numbers show that," says Scott Cooley, a senior fund analyst at Morningstar. "It seems like people are saying, 'I need to be diversified. I can't just load up on one sector like I did with technology.' "

And load up we did. Tech funds' outsize gains in 1999 drew an equally stunning glut of money. Before then the record for one-year inflows to tech funds was $4.4 billion, set in 1995. But they took in nearly $33 billion in 1999 and $43 billion last year, according to FRC.

The Boom Sector funds breeding like rabbits
1995	2001
140	426
Source: Morningstar.

So far this year, the category is bleeding money to the tune of $2.5 billion, or 3% of total assets. This is hardly surprising since these funds suffered significant losses.

A $10,000 investment at the start of 2000 in the no-load (PRSCX Quote)T. Rowe Price Science & Technology fund, the nation's largest tech fund, would've been worth just $4,891.65 at the end of June, according to Morningstar. Even if you'd been prescient enough to invest that money at the start of 1999, before the fund rose more than 100%, you'd still be under water by about $335.

Wilting Tech-fund cash flows track returns

Sources: Morningstar, Financial Research Corp.

Before we shed a tear for cash-strapped fund managers, it's important to remember fund companies played a key role in fueling investors' sector-fund fever. As usual, when they saw steep inflows into sector-fund categories, product pipelines were stuffed with new sector funds to gobble up that cash. At the end of 1995 there were 140 sector funds; today, the tally stands at 426, according to Morningstar. Just 48 of the 148 tech funds out there have been around for three years.

Fidelity, the nation's largest fund shop, offers more than 40 sector-specific Select funds. Last year they took in $5.8 billion, but so far this year redemptions have outpaced investments by some $920 million, according to Lowell.

He believes much of the sector-fund selling may have peaked, but that might not be the case if tech stocks stay down. Diversified growth funds, another top-selling category in recent years, loaded up on tech stocks to stay competitive. That created a double-whammy for investors who thought they were diversified enough to dabble with a tech fund.

A portfolio holding the no-load (VTSMX Quote)Vanguard Total Stock Market Index fund would've lost about 15% in the year ended June 30. But a portfolio with half its money in the same fund and the other half split between the average tech and big-cap growth funds would've lost twice as much, according to Morningstar.

The Price of the Ticket Tech brings longer-term gains at the expense of short-term pain

Source: Morningstar. Returns through Dec. 31, 2000.

Given the drubbing they've absorbed, it's understandable that investors are dumping their tech- and tech-heavy growth funds in favor of bond and tech-light value funds. But it's important to remember the past year's lesson and not completely shift from one style or sector to another because it only ensures you'll be left holding the bag when the latest hot area runs out of gas.

Junk Pile

On Monday, the new I Own What?! column took the Titan Financial Services fund to task for owning tech stocks like Cisco, Intel and JDS Uniphase. You'll be happy to know that today the fund's new managers, Chris Perry and Frank Sustersic, have sold off the fund's tech stocks. Pending shareholder approval of a merger into Perry and Sustersic's Turner Future Financial Services fund, the financial fund will keep its emphasis on financial stocks, according to Turner Funds founder Bob Turner.