Mad Dash to Nasdaq: Fund Flows Inflate Tech Stocks

Today's market is mad, mad, mad for tech stocks, sending those already at thin-air valuations even higher, sometimes for no obvious reason. Except one: Mutual fund investors are stuffing billions of dollars into the sector, and portfolio managers have to invest that money somewhere.

For 1999, investors have pumped $17.8 billion into tech funds through the end of October, according to Boston-based Financial Research Corp. That's far and away a record -- the next-best year is 1995, when $4.4 billion flowed into the sector.

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That influx of capital goes a long way toward explaining the extraordinary rise of the Nasdaq Composite Index, which has surged some 20% in the last month and 80% over the last year.

The money momentum shows no signs of slowing. The $2.7 billion invested in the tech sector during October -- the latest month for which data is available -- is the most ever.

Tech Fever Money has followed hot performance, cooking up even higher returns.

Data as of Oct. 31. Source: Lipper, Financial Research.

Since January, assets in tech funds have shot up 111% while assets in general stock funds have risen just 16%, according to Financial Research. There are now 133 science and technology funds, compared with just 31 five years ago.

This inflow explosion has boosted cash levels at many tech funds as managers scramble to put money to work. It also has created a virtuous cycle of momentum investing as managers push pricey tech stocks higher when they do put the cash to work -- forcing cap-weighted indices and active managers stricken with performance envy to follow suit.

Kevin Landis' (TIFQX Quote)Firsthand Technology Innovators is a poster child for funds overwhelmed by cash. Though its strategy is to be fully invested, it had a cash position equal to 18% of its assets as of Oct. 31.

With returns topping 100% year-to-date, Technology Innovators has been taking in $5 million to $10 million in new investment each day this fall. It was too much for the small-cap fund to handle, and the fund closed to new investors on Monday as assets topped $450 million.

And Landis' fund isn't even taking in the most money.The three best-selling tech funds this year are (MNNAX Quote)Munder NetNet ($2.7 billion in 1999 investment), (JAGTX Quote)Janus Global Technology ($2.3 billion) and (ALTFX Quote)Alliance Technology ($1.6 billion). Janus Global Technology and Munder NetNet have significant cash positions, as of their most recent portfolio disclosure reports.

Cash Rich These tech funds have plenty of money to invest, but it'll be hard to find a bargain.
Fund	Cash %	As of
(TIFQX Quote)Firsthand Technology Innovators	18%	Oct. 31
(JAGTX Quote)Janus Global Technology	17	Dec. 7
(FSPTX Quote)Fidelity Select Technology	12.8	Sept. 30
(FSCSX Quote)Fidelity Select Software and Computer Services	11.6	Sept. 30
(NTTFX Quote)John Hancock Global Technology	10.7	Sept. 30
(TVFQX Quote)Firsthand Technology Value	12.6	Oct. 31
(VWTKX Quote)Van Wagoner Technology	11	Sept. 30
(MNNAX Quote)Munder NetNet	9.4	Oct. 31
Source: Morningstar and fund company Web sites.

Money managers say that when all this money is put to work, already highflying tech stocks will become stratospheric. The average science and technology fund is up 94% this year, according to Lipper.

"This [in-flows] is driving performance. It changes the personality of the market," says Tom Stevens, chief investment officer Wilshire Asset Management in Santa Monica, Calif., which manages $11 billion.

Though companies like Microsoft (MSFT Quote), Cisco (CSCO Quote), America Online (AOL Quote) and Qualcomm (QCOM Quote) are performing well, mutual fund inflows are creating a dangerous enthusiasm for their shares, says Stevens. "We've found an alternative to Las Vegas."

The effect of this cash avalanche extends beyond technology funds and the tech-heavy Nasdaq stock market. The S&P 500 index is market cap-weighted, so tech stocks get a higher weighting in the index as their stocks go up. This means S&P 500 index funds, representing more than $223 billion in investment, have to raise their tech stock allocations to track the index.

For example, on Oct. 31, the (VFINX Quote)Vanguard 500 Index fund had 20.5% of its assets in technology, compared with 14.5% just one year earlier.

So managers of diversified stock funds also have to buy more tech stocks if they want to compete with their peers and with the S&P 500. In the past, managers may have said, "You'll never get fired if you own GE (GE Quote)." Today, the same might go for Qualcomm.

"If you're a multi-billion-dollar growth fund and want to maintain your position relative to your peers, you've got to start playing there [in tech stocks]," says James Grefenstette, portfolio manager of $775.9 (FGSAX Quote)Federated Growth Strategies and $74.4 (FLGBX Quote)Federated Large Cap Growth.

This can send the momentum cycle spinning even faster. "All it takes is a $100 billion fund manager to say, 'I need 2% more Microsoft, and boom -- the bid goes way up," says Grefenstette.

The result is a forked market. At Tuesday's close, the technology-heavy Nasdaq was up 63.6%, compared to 14.6% for the broader-based S&P 500.

"As we talk to growth managers around the country every day, they say they've never seen a market like this, says Phil Edwards, managing director of Standard and Poor's Fund Services unit.

But investors should remember that trees don't grow to the sky, and this momentum cycle -- progenitor of pleasing triple-digit fund returns -- will be painful when it ends.

That's when a virtuous cycle turns into a vicious one.