Like a battered heavyweight with a second wind, black-eyed tech and tech-stuffed growth funds have come out of the corner swinging over the past 90 days. The dramatic flurry, however, only proves why you should spread your bets.
Thanks to hopes that the economy and corporate profits will stop sagging this year, the average tech fund has lapped a rising market, shooting up some 41% over the past three months. In fact, some tech-heavy growth funds are actually up more than twice that much over the same period.
The burst is rare good news to these ravaged funds' remaining, long-suffering shareholders. But it hasn't erased these funds' steep losses over the past two years, either. It would be easy to get swept up in this recent rally, but to the savvy fund investor, this splendid run-up underscores the primary (and perhaps tired) lesson fund investors have learned since 1999's tech mania: diversify.
Here's why: Investment styles and market sectors, particularly the growth style and tech sector, tend to rise and fall in sudden, unpredictable gushes. If you ignore an area, you'll probably miss out on some big gains, but if you bet the farm on the leader du jour, as many did in 1999 and 2000, you'll eventually suffer outsize losses. So, spreading your money broadly among a blend of different stock funds positions you to benefit from eye-popping runs like this one, without losing your shirt when the siren song stops.
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To say tech and growth funds' powerful run isn't both powerful and intriguing would be silly. After all, plodding bond funds topped all flavors of growth and tech funds over the past two years.
And in these heady 90 days, some of the most concentrated, aggressive and tech-obsessed funds out there have rung up gains that you'd expect from a volatile penny stock rather than a mutual fund. As you might imagine, the ultramercurial Van Wagoner funds, led by tech evangelist Garrett Van Wagoner, dominate the list of highfliers over the past three months. Some will wonder if the firm's controversial pricing of its private-company holdings helped out, but the returns are stunning nonetheless.
Technology fund tops all tech funds, excluding leveraged trading funds, with an 80% gain. Its
Emerging Growth and
Post-Venture funds surged more than 80%. How did they ring up such high gains in such a short time? Collectively the firm's funds had 90% of their money in tech stocks, according to a Sept. 30 regulatory filing. Faves like software shop
and network switch maker
propelled the funds. Both stocks are up some 150% over the past 90 days.
Of course, a look at these sizzling funds' longer-term returns hits like a bucket of icy water. The three Van Wagoner funds that are up more than 80% over the past 90 days have still lost more than half their value over the past year. If you're wondering how that's possible, consider that many of these ultra-aggressive funds and others of their ilk
sported an 80% one-year loss not long ago. The Post-Venture and Technology funds are still in the red over the past three years, implying how far many investors still are from break-even.
Obviously, these funds, a good fit for precious few investors, are drastic examples of how dangerous it can be to make a big bet on the tech sector or growth style. But tamer examples are just as illustrative. The
Fidelity Aggressive Growth fund rode big tech bets to a 103% gain in 1999, and the big-cap fund from the nation's largest fund shop was among 2000's bestsellers. Since manager Erin Sullivan's departure, however, the fund has sputtered and now averages a 9% annual loss over the past three years.
A $10,000 investment at the start of 2000 would've been worth less than $3,500 at the start of December, according to the latest data from Morningstar. Even if you'd been prescient enough to make the same investment on Jan. 1, 1999, you would still be in the red by more than $3,000. We recently
found several funds that gained more than 100% in 1999 that have lost all of those gains and more.
These bleak numbers don't mean you should completely avoid growth and tech funds, though many fund investors did last year. Rather, they prove that you should shoehorn them into a diversified portfolio, as a rough example illustrates.
In the second half of the 1990s, cash flows to stock funds began skewing drastically toward growth and tech funds because those funds were performing best at the time. But if we compare one portfolio invested solely in big-cap growth funds with one split between only big-cap growth and tech-light, bargain-hunting big-cap value funds, we see why diversification makes sense in the long run.
The all-growth portfolio and the growth/value portfolio both averaged about a 12% annual gain over the past decade. But the diversified portfolio's route to those returns was far smoother. Its worst quarterly loss was 17%, compared with 23% for the growth portfolio. A comparison of each portfolio's beta, or volatility, vs. the
underscores this point.
If you're not familiar, the S&P 500's beta is 1.0, and a lower beta implies less volatility, while a higher beta implies more bumps in the road. The all-growth portfolio had a 1.3 beta, so it tended to outdo the index by about 30% on the upside and fall about 30% further on the downside. The diversified portfolio's 0.99 beta indicates a less hectic ride.
The bottom line is that it's easy to get swept up in the swirl of these gains, particularly if they continue for a spell. But tech and growth funds' recent hot streak and their losses in past years prove the same thing: Moderation is the fund investor's best policy.
Ian McDonald writes daily for TheStreet.com. In keeping with TSC's editorial policy, he doesn't own or short individual stocks. He also doesn't invest in hedge funds or other private investment partnerships. He invites you to send your feedback to
email@example.com, but he cannot give specific financial advice.