Don't fold those pitiful tech funds just yet. A second-half comeback just might be in the cards.
The average specialty technology fund is down 5.28% in 2005, making it Morningstar's worst-performing category among all equity mutual funds. That's a long way down from the top of the table, where energy and utility funds have soared 16% and 11%, respectively, since the start of the year.
Karen Papalois, Morningstar's tech fund analyst, says the category, which boasts 289 funds holding a combined $34.8 billion in assets, has been out of favor for some time, but is "due for a comeback."
Papalois is not alone in her belief that tech should rise again in the second half. Fund managers, Wall Street analysts and even a certain "Mad Money" man named Cramer have been pounding the table about tech's comeback, urging investors to get over their postbubble trepidations and begin buying again.
Let It Flow
Tech fund inflows have been paltry this year. The pace is so weak, in fact, that if it keeps up 2005 will be the second-worst year for tech funds in more than a decade, according to fund-flow tracker TrimTabs Investment Research.
Therein lies the opportunity. Shareholders may be shying away from tech funds, but that's a good sign, says Charles Biderman, TrimTabs president. Biderman notes that after a year of outflows in 2002, the
surged by 50%. In 2000, however, inflows were a record $309 billion, $260 billion of that going into U.S. equity funds. Unfortunately, those funds arrived just in time for the market to start its steady downfall.
"Weak fund flows are a contrary indicator," Biderman says. "Individual investors have always been wrong when they move to extremes."
Silly retail investors aside, history and seasonality also favor a tech rally.
Jonathan Rudy, a tech analyst at Standard & Poor's specializing in software companies, notes that tech shares have risen in the second half in 11 of the last 12 years. A lot of that outperformance, says Rudy, is due to investor enthusiasm in advance of new products being rolled out in the fourth quarter, as well as the so-called "budget flush," when corporate information technology officers spend money for fear of losing those dollars the following year.
"People get excited about the fourth quarter, especially in software, because of the budget flush," says Rudy, comparing it to government agencies that either spend or lose their appropriation.
Software companies should be the big winners, says Rudy, especially
, which will be rolling out a new version of Xbox ahead of the Christmas holidays. Microsoft will also benefit from the fourth-quarter buzz ahead of the release of its Longhorn operating system in 2006.
He also likes
( MFE), a provider of security software, an area that, he says, should get increasing amounts of tech budget dollars -- before they get flushed, of course.
Ed Maraccini, portfolio manager at Johnson Asset Management, has another reason for believing tech's fortunes will soon be turning.
"Corporate America has plenty of cash on their balance sheets, and they will reinvest in infrastructure in the second half," says Maraccini. "The consumer has spent his money up till now keeping the economy afloat and the corporate side will start picking up the slack from here."
With that in mind, Maraccini favors tech companies like
( ATSN), a power conversion equipment supplier that should benefit from companies choosing to reinvest in their tech infrastructure.
Maraccini admires Artesyn's low debt and a strong cash flow. He cites the same reasons for choosing Internet software company
, which has zero debt and might also be a potential takeout play.
Tech Your Time
Even though the sentiment tide seems to be turning in favor of tech funds, the pros are advising investors to remember the lessons of the bubble and not go overboard.
Morningstar's Papalois reminds investors about the volatility of tech funds, a trait that should be used to support a diversified portfolio.
"Tech funds are often used incorrectly by investors bent on chasing performance," says Papalois, who also criticizes them for being unnecessarily pricey with expense ratios typically near 2% for a fund's A shares, well above the average stock fund fee of 1.5%.
Furthermore, with expectations of a second-half rally so widespread, some tech analysts say that a lot of the big tech buying has already come and gone.
Mark Demos, analyst at Fifth Third Asset Management, says that savvy investors are well aware of the role that seasonality plays in tech trading, which is why some of the expected rally may have occurred in April.
"People have already been front-running the second-half rally, so it might be a bit more muted this year," says Demos. And on a historical note, Demos points out that the overall economy has picked up in the second half in the past, but oil's rise "may make it tough to for the economy to get its traditional second-half growth spurt."
That said, Demos likes
, which he says will keep increasing its market share at
expense. He also likes
, another security provider, due to its hot sector and strong fundamentals.
Finally, for those investors who were burned by tech funds before and are still too scared to jump back in, another option is to sit back and wait for the market to provide you with some guidance.
"Since the bubble burst, tech funds have done exceptionally well when the
has done well and have significantly lagged when the S&P has stumbled," says Lipper strategist Andrew Clark. "So essentially you are making a bet on the direction of the S&P."
To view Gregg Greenberg's video take on the possible second-half comeback for tech funds, click here.