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Fund Investors' One-Track Minds Pushing Tech Higher

Fund families that don't have tech funds find they need to start one in order to get a piece of the action.
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Stock mutual funds and their shareholders are betting more heavily on the pricey and volatile tech sector than ever before -- essentially carrying Hefty bags full of money further and further out on a tenuous limb.

This mass love affair with the sector is forcing stock fund managers of all flavors to own tech stocks in order to compete with their competitors and benchmark. And fund companies without a tech-sector fund are rolling them out left and right to stay competitive. The upshot is that fund investors -- and the fund industry itself -- are chasing hot money in a big way, and it could be painful when the sector cools off.

In January, investors stuffed $9.3 billion into tech sector funds -- more than half the money invested in stock mutual funds that month, according to Boston fund consultant

Financial Research

. January's inflows came on top of $33.5 billion that poured into the sector in 1999, when the

average

tech fund rocketed up 136%.

The 1999 total is a stunning amount of money any way you look at it. For instance, the previous calendar-year record was 1995's $4.4 billion -- an amount tech funds topped monthly in November, December, and January. Last year, tech funds took in more money than

S&P 500

index funds, and in January they lapped them more than three times.

"I've never seen such a high concentration of investments into such a limited sector of the market," says Burt Greenwald, a Philadelphia-based consultant who's worked in the mutual fund industry for 40 years.

Go Where the Money Is
Spiraling returns have attracted a flood of investment dollars into technology.

Source: Financial Research

This glut of new cash has played a vital role in sending tech stock prices north from already stratospheric levels. Fund inflows have boosted the hot sector higher, drawing in more inflows.

"It's entirely cash-flow driven. Tech fund managers are getting heavy inflows and they need to be invested. Fund flows continue to push up prices, but it's not so much a judgment of

a stock's valuation, but of cash-flow logistics," says Syl Marquardt, research director at

John Hancock Funds

, whose

(NTTFX)

Global Technology fund is up 178% over the past year.

But tech funds are just the tip of the industry's iceberg-sized tech bet. The sector's appreciation has ratcheted up its representation in the

S&P 500

index, so more than 25 cents of every dollar invested in the $230 billion S&P 500 index-fund category goes to the tech sector.

And because many funds are trying to beat that benchmark, most domestic stock funds, which took in nearly $142 billion in 1999, have followed suit rather than be left behind. At the start of the 1990s, the average domestic stock fund had a 2.6% tech allocation; by the end of 1999, it topped 24%, according to

Morningstar

.

For instance, Morningstar says

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PBHG Large Cap 20 is a large-cap growth fund, but at year-end, it had more than 75% of its assets in tech stocks. The fund is up more than 143% over the past year.

Investors' love affair with

Janus

is boosting the industry's tech bet, too. The $250 billion Denver growth shop with a

big tech appetite set the one-month sales record for a fund family in January with more than $9 billion in inflows -- 50 cents of every dollar invested in domestic stock funds that month.

Of the 10 stocks in which the firm has invested most heavily, six are in the tech sector, according to

bigdough.com

, a Web site that tracks institutional ownership. Its average stock fund has a 30% tech allocation, according to Morningstar.

Of course, if fund investors get spooked and turn off the cash spigot, they could help send the sector plummeting, just like they helped prop it up. Many fund watchers believe fund flows already have sent tech stocks to unsustainable levels, and that the sector is addicted to funds' inflows and could teeter without them. The average tech fund's price-to-earnings ratio is 52.8, nearly double the S&P 500's.

The tech sector certainly has many excellent companies, but when their stock prices eventually come down to Earth, funds and fund investors could be in for a hard landing.

"It's inevitable that

tech stocks will slow down. When it ends, it will be tearful for those left holding the bag," says Hancock's Marquardt.

It could be particularly painful for both funds and individual investors, because neither appears to have much wiggle room right now. The average U.S. stock fund's cash position is the lowest it's been in 20 years, and individual investors' margin debt is dangerously high, says Charles Biderman, president of independent newsletter

Liquidity Trim Tabs

. That leaves funds and investors with little flexibility in a selloff.

"Some event will trigger a change in the psychology regarding these stocks and the air will come out of the balloon," says Greenwald. He fears a tech correction could bring the whole market down 20% to 25%. In that case, he says, many of today's fund investors with inflated expectations -- especially those who weren't invested in the market in the crash of 1987 -- will hit the exits and question the fund industry's credibility.

Credibility could come into question if things turn particularly ugly, because fund shops have caught the performance-chasing fever, too. Not having a tech fund means missing out on a ton of new money, so fund firms like

Loomis Sayles

,

Neuberger Berman

and

Delaware Investments

, which have no particular reputation for picking tech stocks, have rolled out tech funds this year.

And they're not alone. Tech funds make up about 5% of no-load stock funds, but so far this year, 40% of new funds have focused on the tech sector, says Jonas Max Ferris, chief executive and co-founder of

Maxfunds.com

, a Web site that tracks no-load stock funds with a focus on new and obscure funds.

Since 1995, the number of tech funds has tripled to 61, according to Lipper, but that doesn't factor in the glut of new funds that don't have ticker symbols and aren't in the fund tracker's database yet. Today, there are at least 25 funds focusing on the Internet alone, with many more in development.

Given the tons of money riding on the sector already, one wonders how many more funds and dollars that limb can support before it begins to crack?