Jacob's Internet Strategy Hits Bump in Road

The smaller-cap Net stocks he favors are being outrun by large-cap tech blue-chips.
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Since Ryan Jacob

launched the

(JAMFX) - Get Report

Jacob Internet fund on Dec.13, he's stuck to the style that made his old fund, the

(WWWFX) - Get Report

Internet fund, No. 1 in 1998.

He buys relatively cheap mid-cap Internet stocks and spurns pricey "blue-chip" tech juggernauts like

Cisco

(CSCO) - Get Report

and

Intel

(INTC) - Get Report

.

That approach isn't paying off so far this year. His new fund is down 2.5% since Jan. 1 and is trailing most of its competitors, including his old fund.

Looking for smaller stocks -- rather than focusing on the big companies the market has already discovered -- is where an Internet fund manager can add value, says the 30-year-old Jacob. While his approach might produce higher returns with less risk down the road, it has held him back so far. Intel is up 28% this year through Friday's close, and Cisco is up 17.4%.

(MNNAX) - Get Report

Munder NetNet, the largest Internet fund, with $7.7 billion in assets, and

(MFITX)

Monument Internet, last year's top-performing Net fund, with a stunning 273% return, both count Cisco, Intel and

Sun Microsystems

(SUNW) - Get Report

among their top 25 holdings, according to

Morningstar

.

Aside from shunning big-caps, Jacob also has refused to pay thin-air prices for traditional Net stocks like

DoubleClick

(DCLK)

or

Exodus Communications

(EXDS)

. But that's nothing new for Jacob.

"He did look at valuations

when he managed the Internet fund, and to the extent that anyone can be valuation sensitive in that area, he was," says Scott Cooley, a Morningstar analyst who covers the fund.

Again, that cautious approach may pay off long term but doesn't look so great now. When Jacob Internet launched in December, he took a couple of weeks to get the fund fully invested because he wasn't comfortable with prices then. Unfortunately, many of the companies he avoided have paid off.

They include

VeriSign

(VRSN) - Get Report

,

Inktomi

(INKT)

and

Broadcom

(BRCM)

. He owned them in the Internet fund and believes in them, but he hasn't bought them for the new fund because he thinks their prices are too high to offer enough upside potential. So far this year, the stocks are up 24.2%, 38.1% and 39.5%, respectively, through Friday's close.

What's in Jacob's fund?

It's fairly evenly divided among several Internet subsectors, including content plays like

NBC Internet

(NBCI)

, infrastructure stocks like

Critical Path

(CPTH)

, communications stocks like

Phone.com

(PHCM)

and commerce stocks like

Drugstore.com

(DSCM)

. Through Friday's close these stocks were down 18%, down 22.1%, up 18.7% and down 44.7%, respectively, for the year.

Of the Jacob fund's top-10 holdings,

GoTo.com

(GOTO)

, up 22.8%, and

StarMedia Network

(STRM) - Get Report

, up 32%, are his best picks.

But four of those 10 stocks are down more than 20% for the year, including onetime top holding

CMGI

(CMGI)

, down 21.7% through Friday's close. The other three are Critical Path, Drugstore.com and

Ask Jeeves

(ASKJ)

, down 39%.

The median market cap of stocks in Jacob's fund is between $1.5 billion and $2 billion, by his estimate. The average stock in other Internet funds is four and five times larger, according to Morningstar.

Some of the bigger Internet funds, like NetNet, buy large-cap stocks because it's difficult for big funds to take substantive positions in small stocks. It's also difficult for a big fund to build or reduce a position in a small-cap stock without moving its price and reducing the fund's return.

But, despite their recent gains, these big-cap issues don't offer the same return potential as smaller companies and could be peaking, Jacob argues. He thinks investors have reached an "infatuation stage" with these companies and doesn't think the issues necessarily fit the definition of a Net stock.

Of course, it's a bit difficult for anybody to define just what is and isn't a Net stock these days. The

(WWIFX)

WWW Internet fund, for instance, held

Wal-Mart

(WMT) - Get Report

and

Merrill Lynch

(MER)

at year-end.

Maybe the most frustrating part of this year, Jacob says, has been seeing his Internet fund picks, like Broadcom and Inktomi, boost his old fund and other competitors while he sits on the sidelines.

But the patient approach may pay off. Jacob delayed a foray into hot business-to-business, or B2B, Internet stocks for valuation reasons. Recently he added two B2B stocks,

Commerce One

(CMRC)

and

Chemdex

(CMDX)

, after they dropped to what he thought were attractive prices.

Jacob says he's comfortable with his portfolio and approach, and aside from message-board critics, investors appear to be content to see how things pan out. The fund launched with $150 million raised during a two-week subscription period. Today the fund has $270 million, according to Jacob.

But if returns don't turn around by year-end, it's safe to say that more than a few investors might start asking, "What have you done for me lately?" That might seem like a pretty quick trigger, but Internet time extends to funds, too.