Open Fire: Newborn Net Funds Get Burned for Chasing Hot Trend

A few months ago, the throng of mutual-fund companies stampeding to offer Internet funds roared like bulls. Now, they're drowning like lemmings.

As 1999 began, there were just four Internet-focused funds. But triple-digit returns and mountainous inflows prompted a scramble among fund shops, large and small, eager to get their share of the Net-fund pie. In the past six months, nearly 20 Net funds have rolled off the assembly line, and at least five more are slated to launch. The problem is, the pie has gotten a lot smaller: Since TheStreet.com Internet Index's March 10 peak, it's down more than 34%.

"I'm really starting to think fund launches are the best contrarian indicator out there," says Jonas Max Ferris, co-founder of MaxFunds.com, a fund-tracking Web site. "[Companies] launch funds when they see the money gushing into a category and by the time the fund comes out, it's already too late."

The lesson fund companies are now learning is the very same one they always offer to individual investors: Don't chase hot sectors, because you'll get burned. Now, investors eyeing Net mutual funds face a challenge akin to managers of Net stocks: When surveying the dot-com rubble, ask how many of the choices will be around in five years.

And just because the Internet sector has nose-dived, that doesn't necessarily signal an automatic buying opportunity.

"The valuations have only gone from absurd to ridiculous. I'm not that negative on Net stocks, but I wouldn't invest here," says Syl Marquardt, research director at Boston-based John Hancock Funds, which has a (NTTFX Quote)Technology fund, but not an Internet fund.

Net Losses 18 Net funds have rolled out in just six months and more are slated. All but one of the rookies are underwater since Jan. 1.
Net Fund	Inception	YTD Return (%)
Integrity Internet Index	Nov. 4, 1999	-30
StockJungle.com Pure Play	Nov. 17, 1999	-30.9
Investors Capital Internet*	Nov. 18, 1999	-15
(RIAFX Quote)RS Internet Age	Dec. 1, 1999	-15.4
(PNETX Quote)Potomac Internet Plus	Dec. 1, 1999	-43.2
Potomac Internet Short	Dec. 1, 1999	-7.7
Westcott Nothing But Net	Dec. 8, 1999	-32
(JAMFX Quote)Jacob Internet	Dec. 13, 1999	-37.7
(WWWIX Quote)Kinetics: Internet Infrastructure	Dec. 31, 1999T	-9
(WWWEX Quote)Kinetics: Internet Emerging Growth	Dec. 31, 1999	-25.3
(WWWGX Quote)Kinetics: Internet Global Growth	Dec. 31, 1999	-5.9
(WWNPX Quote)Kinetics: Internet New Paradigm	Dec. 31, 1999	-12.3
(SNETX Quote)Strong Internet	Dec. 31, 1999	-12.4
Baron iOpportunity	March 1, 2000	-13.4
(MANTX Quote)Merrill Lynch Internet Strategies	March 22, 2000	-33.7*
Rydex Internet	April 6, 2000	-16.1
Munder International NetNet	April 10, 2000	-7.4*
iMillennium	April 19, 2000	4*
Ariston Internet Convertible Fund	May 1, 2000	N/A
TheStreet.com Internet Index	N/A	-25.1
Source: : Lipper, Morningstar, MaxFunds.com, and fund company Web sites. Performance figures through May 5. *Since inception.

The crushing blow for many of the funds is a reality of today's market: Stocks may move in Internet time, but regulators don't. The funds filed with the Securities and Exchange Commission months prior to their launch, when Net stocks were still riding high.

Take high-profile wunderkind Ryan Jacob. He filed to launch (JAMFX Quote)Jacob Internet in July, just after he left his post on Kinetics' (WWWFX Quote)Internet fund, where he beat all funds with a 196% return in 1998.

But prolonged scrutiny of Jacob's paperwork delayed its launch until December. Goldman Sachs filed its (GITAX Quote)Internet Tollkeeper fund two days after Jacob filed for his, but launched its fund two months earlier. In those two months, TheStreet.com Internet Index rose more than 78%, while Jacob sat on the sidelines.

Most managers say investors have stuck with their funds through their tribulations early this year. Jacob says investor redemptions have been around $10 million. The fund's total assets are $160 million.

The gush of new funds appears to be the result of reactionary "me too" marketing, as rocketing Net stocks inflated fund returns and drew investor dollars away from value funds and other core categories. Before 1999, the tech-fund category's record calendar-year inflow was $4.4 billion. Last year, the category took in more than $30 billion and (MNNAX Quote)Munder NetNet alone gobbled up $3.7 billion in fresh cash, according to Boston fund consultant Financial Research.

"Many of the recent launches have been a defensive move. When people see the Munders of the world raising billions, they figure if others can do it, they can do it," says Dave Haywood, director of research at Financial Research. He adds that recent, uncharacteristic tech-fund launches from firms such as MFS, Pioneer and Neuberger Berman show that a Net or other tech-sector fund may have become a necessity as nonbelievers tired of watching money flow to the sector.

No matter what motivation brought the new Net pack to market, each got smacked upon arrival. Most blame prices that had reached absurdly high levels. Only one of the rookies, the obscure iMillennium, which debuted April 19, is above water so far this year. (Integrity Internet Index is down for the year, but up 9% since its Nov. 4 inception.)

"I think valuations had gotten ahead of themselves and everyone knew that before the correction," says Jacob. He concedes "pure play" favorites like Lifeminders.com(LFMN Quote) and iVillage(IVIL Quote) have "really taken a pounding." His fund is down 37.7% since Jan. 1, trailing his old fund by 15 percentage points over the same period, according to Morningstar.

But he's not suffering alone.

"Almost nothing has held up as well as I'd have expected," says Rob Zidar, co-manager of Merrill Lynch's (MANTX Quote)Internet Strategies. Merrill actually launched the fund for foreign investors last October, but didn't roll out the U.S. version until March 22, 10 days after the TSC Internet Index peaked. The fund raised more than $1 billion when it launched. Since then it's down more than 30%.

Both Zidar and Jacob say investors haven't dumped their funds en masse, but April flow figures aren't available yet. Not surprisingly, both managers say they see buying opportunities, albeit in different places: Zidar likes infrastructure plays like Exodus Communications(EXDS Quote) and Tibco Software(TIBX Quote), while Jacob still likes a few B2B stocks and B2C stocks like Ask Jeeves(ASKJ Quote).

Each of these picks is down more than 40% since Net stocks peaked on March 10, but the managers think they'll pay off down the road. It's a tough call, quite similar to a fund investor choosing among this basket of funds with steep losses, many of which from managers with little or no track record. Though Jacob is considered one of the category's graybeards, he managed the Internet fund for only 19 months before he decided to do his own thing.

Another problem is that many of these new funds carve the Net into pretty specific and perhaps constrictive slices: IPOs, venture capital, and small caps (Internet Emerging Growth), infrastructure stocks (Internet Infrastructure), foreign Net stocks (Internet Global Growth and Munder International NetNet), and convertible securities issued by Net companies (Ariston Internet Convertible).

Given the sector's volatility, it might be best to go with an experienced manager from an established shop whose fund doesn't get painted into a corner by a restrictive focus on one sector. You might consider Morningstar Manager of the Year Jim Callinan, who co-manages (RIAFX Quote)RS Internet Age. He's built an eye-catching record running tech-heavy (RSEGX Quote)RS Emerging Growth since 1996 and (POEGX Quote)Putnam OTC & Emerging Growth for two years before that.

You also might want to look beyond this pack of Johnny-Come-Latelys to other Net funds with tenured managers like (EIFAX Quote)Enterprise Internet, run by David Alger, or (if you like e-commerce) (TEFQX Quote)Firsthand e-Commerce, run by Silicon Valley guru Kevin Landis. A wait-and-see approach makes sense too. Though the sector is a lot cheaper than it was a few months ago, it has more room to fall.

Why then does it seem like there's a new Net fund born every day?

"You have to have something customers want to buy. ... To paraphrase P.T. Barnum, there's an investor born every day," says John Hancock's Marquardt.