Here's something you don't hear every day: A tech fund manager likening his investment style to stodgy techphobe
Manager: Mark Herskovitz
Fund: Dreyfus Premier Technology Growth
Managed since: Oct. 13, 1997 (inception)
Assets: $1.5 billion
Three-year return/Ranking: 29.9%/Beats 93% of Peers
Sales charge/annual expense ratio: *5.75%/1.12%
Top three holdings: Verizon Communications;
Sources: Dreyfus and Morningstar. Annualized returns through April 20. *Sales charge and expense ratio are for Class A shares.
Mark Herskovitz is different from many of his peers. He tends to hold his picks more than a quarter or two and he's not afraid to admit that he's sought shelter in less sexy tech names like payroll shop
Automatic Data Processing
as the tech sector buckled. Although the
is down more than 55% from its peak last March, Herskovitz, unlike a lot of tech specialists, doesn't think tech shares, in sum, are a screaming buy.
Given that less racy style, you might expect some meager returns, but that's not what you'll find. Herskovitz's
Dreyfus Premier Technology Growth fund launched toward the end of 1997 and he's managed to beat his average peers in each calendar year since -- hardly a smooth period. Yes, he's down more than 40% over the last year like a lot of his peers, but his 29.9% three-year average return quietly tops more than 90% of the tech funds out there.
What's his take on what might heal the hurting sector and whether bellwethers like
will emerge in decent shape? Well, you'll just have to read on.
1. When we look at the market today, where do you see strength, and which specific stocks do you like within those sectors?
Among my top holdings are the RBOCs -- the regional Bell operating companies.
Interesting. What do you see?
Well, a bunch of things. As of the end of March, our largest position was
; second largest was
; third largest position was
Automatic Data Processing
, or ADP.
But among the Top 10, I also have
is very close.
This is the thesis. First of all, we're in a terrible market for these defensive companies. Having said that, I think there are very fundamental reasons for liking the RBOCs.
Number one, they are facing, in my opinion, much less competition than the market saw just a few, just a year ago or two years ago.
Think about the outlook for the RBOCs 18 months ago. They were going to lose a tremendous amount of share from their most profitable business customers because of the CLECs. That was the whole thesis, in a nutshell.
Well, the CLEC industry is in terrible financial shape. Then, on the residential side the worry was about
, and AT&T's $110 billion. They were going to provide cable access and they were going to turn that into a local phone infrastructure. That whole strategy is dead in the water, I believe. AT&T is aggregating itself, and yet the valuations of the RBOCs as a group, relative to the S&P, is essentially the same as when the market was fearing all of those concerns.
In addition, you saw that Massachusetts approved Verizon's application to offer long-distance service
as did the
; it's expected that many of the RBOCs will send in many more applications; to the extent that the RBOCs can get into long distance, it's a huge benefit for them.
Verizon got 20% of the long-distance business in New York state in a year, without really any heroic effort on their part. I see all of these fundamental positives, and the stocks haven't increased in relative value.
And they are also starting from a much lower valuation than virtually any other direction you look in the sector.
Yep. So they're low valuation, relatively steady business model in a difficult period, tons of cash flow, established customer relationships, lots of good things.
In Sickness and in Health
Source: Morningstar. Returns through April 20.
2. When you invest in a company, what kind of time horizon do you have in your mind? Do you set price targets, or do you focus more on the company and not as much on price of the shares at any given time?
We do not use price targets. And we don't have a time horizon at what I would term an arbitrary framework. I don't think that the business world is like that. If we want to own that company, until there is a material deterioration in the fundamental outlook.
If there isn't that material deterioration, not in the cyclical outlook, but in the fundamental, secular outlook, why should we sell it?
If you look at where people really make money as investors -- look at the example of a Warren Buffett -- you really make your money when you buy a company and hold onto it, and that company is a successful business.
Look at technology for the last decade. What are the really big winners? It's
. If you had bought any of those companies and they had doubled in price the first year or two and you'd sold them out, you would have left so much money on the table, it would have been unconscionable.
Of course, a lot of people embrace this strategy, but you can't put blinders on to a fundamental change in business when things turn negative.
Absolutely! Again, we will make transactions based on changes in fundamentals. However, I would argue that much of Wall Street talks about fundamentals investing; what they're really focused on is valuation.
When you talk about valuation in the stock market, I think the unspoken premise is that the market in the short run is very irrational, and so I'm going to establish what I think is the fundamental value of the company and if I think the market is irrationally undervaluing it, I'm going to buy it.
But when the market is irrational in the other direction, I will sell it.
First of all, I think it's very, very hard to do that consistently right. Second of all, even if you do it right consistently, you're going to generate huge tax liability for your investors.
If you take a look at last year, we did better than our peers in a down market. I think we outperformed the Nasdaq by about 10 percentage points, yet we distributed zero capital gains.
We had competitors that distributed 30% of net asset value in capital gains with worse absolute performance.
3. Apart from the Regional Bells, what other areas are interesting you in the past few months?
The stock that we've done best with, oddly enough, is a semiconductor company,
A great little company. We are not (on a long-term secular basis), we are not bullish on the PC industry, because it's mature in its growth from a revenue point of view.
But, it's a huge industry. If your product is taking a lot of share in the PC space, you can grow quite rapidly. That's what's happening with the graphics -- the high-end graphics accelerator chips in general, and in particular, with Nvidia. So, for example, a relatively small percentage of notebook computers two years ago had high-end graphic chips, now many of them do. And I think one of the reasons is, because, if you want to buy a PC or a laptop and you buy it with the latest P4 from Intel, you pay a very big premium to get the very latest generation microprocessor, for relatively little noticeable improvement in performance.
I think one of the selling points is if you put in a higher-end graphics chip, it's less expensive to go to a higher level and you get a very significant improvement in the computing experience in terms of what you actually see.
Nvidia is clearly the technology leader; they are far ahead of competitors in terms of the quality of the products and they have just taken share all over the place.
10 Questions Archive
Value Veteran Bill Lippman
Hancock Technolgy's Marc Klee
Financial Planner Harold Evensky
Merrill Lynch Fundamental Growth's Larry Fuller
4. Is there value in the Nasdaq after the 55% drop-off in the past year. If so, where, and where is the value, and where are the value traps?
Hopefully, not too many people are going to confuse price and value, because the price is meaningless from a stock market point of view, other than when you bought it, what is it trading at today. It doesn't say anything about the value of the company, just because the price is down 50%.
It could be more expensive on a multiple basis than one that is twice the price, so I think that it's very hard to say with a broad brush that the Nasdaq is a good buy here because prices have come down a lot.
What I would say is, we've gotten to an awful lot of extremely bad news. I mean, I don't think there's anyone who wants to minimize the violence of the fundamental downturn. It's reasonable that the stocks are down so much. The other question is: Is it going to get a lot worse, or, is it going to get less worse? I'll probably get in trouble for having used that expression, but you understand what I'm saying.
My sense is that while it is going to remain considerably difficult, on the margin it's probably not going to show continuing downward acceleration.
And you know, the market's insane. They won't view that as a positive. Maybe we have actually put in a bottom, or we're certainly very, very close to a bottom here.
I thought it was interesting the other day with Jonathan Joseph's note on the semiconductors where there wasn't really any positive news, he just sort of said he didn't think it could get much worse and people just ran with that as being a glowing comment.
I think two things happened. Number one: The shorts got squeezed, this massive short position is all over the street, so whenever anybody who has got any kind of influence says something in the other direction, these guys have no choice but to start buying like mad.
Short-selling is a big part of it, but also Number two: Most people don't think that Cisco or communications, say, is going to go out of business. So if you want to be in the sector longer-term, you better be owning it at around in here. The odds of you being able to own lots of different companies at significantly lower prices from here is less than the odds that you're going to have to start paying more if you wait.
5. A quick screen looking at the big-cap tech stocks that are holding up best over the past 12 months turned up ADP, which you own. It has held up a bit better than most of the sort of household-name tech stocks. Is this a year of unsexy tech, or is it just that these more defensive plays are bulling up a bit?
I think it's the latter. They're defensive plays, they have steadier, more assured revenue than the product-oriented companies. People like them when things are getting very frightening.
6. I get a lot of emails from folks that bought shares of tech funds in the past year or so, many coming in after big gains were booked. They showed up at the end of the party. They often ask: "Why didn't these tech fund managers go to cash or raise cash when things were really just falling to the floor?" What's your response to those kinds of questions?
My response is that people need to understand very clearly what the goal of a mutual fund is. A mutual fund is not a hedge fund. I believe it's fair to say that what a mutual fund is supposed to do is to outperform its asset class over the different cycles.
So when the Nasdaq is up, I'm doing my job well if I go up more. And when the Nasdaq goes down, I do my job well if I go down less. So there are investments, there are investment vehicles that stress no loss.
For example, a true hedge fund, I think, would be something that really tries very, very hard never to have a loss. There's a price for that, which is if you are truly fully hedged, or mostly hedged, you're going to go up a lot less.
My fund was up 98% in 1998, 158% in 1999. You should not get returns like that in a hedge fund. Because I think if they did they really wouldn't have been hedged. They would have been too exposed to the long side.
In a sense, asking why mutual fund managers didn't go completely to cash, the answer is because we're supposed to do better on the downside than the market, we're not supposed to
lose money. Would every mutual fund manager want to never not lose money? Of course!
But you have to be realistic about it. There's a price to doing strategies that would result in that. And that's not what mutual fund investors are expecting.
Higher Highs and Lower Lows
Source: Morningstar. Returns through March 31.
7. What's the biggest mistake somebody can make in this market?
This is going to sound very stupid, because it's pretty obvious, but you don't have a chance of getting the right answer if you don't ask the right questions.
So, I think the right question should be, what is a person's long-term opinion about technology? Or another way of saying it is, is this downturn a cyclical downturn, or a secular downturn?
I think it makes a big difference. My opinion is this is actually a fairly typical cyclical downturn. Now people could say, but wait a second, how can you say it's typical? The market's never gone down this much this quickly.
That's true, but that's strictly a function of how fast it went up. It had gone up as much as it did that quickly, so that's just the mirror image of the upward move.
But I don't think that the downturn says anything about the asset class being fundamentally impaired. People are wondering, well, maybe it's all over for tech, and tech is going to be like the U.S. commercial real estate market where it was in a depression for a decade, something like that.
If you thought that, you should not be in tech at any price. It's an extreme opinion, but if you think that this is a cyclical downturn, and you're in the stocks today, I think you're going to have a very, very difficult time doing well in tech, if you bail out in here.
I think the key is that people should do asset allocation. Tech should be an appropriate percentage of their portfolio, based on the usual criteria. My fund is distributed through investment advisers and I really believe that those guys perform a valuable service.
You know, if you could do it yourself, that's fine. But for many people, it's pretty complicated and if you have a lot of assets, it's time-consuming. It's helpful to have asset allocation. So you decide: What's your risk tolerance? When are you going to need the money? All that other stuff.
8. Would you mind playing tech-bellwether word association? I'll name a stock, and you let me know if you own shares and where you see the business going. First one is Cisco.
We have a small position in
. My concern is, what kind of company will Cisco be when it comes out of the downturn?
Is it going to be the 30%-50% growth that it's been for the last decade, or is Cisco going to emerge from this cyclical downturn as a cyclical growth company like an
or something? I don't know that they'll be quite that mature right away, but I think it may be tough for them to get back to the fast-growing space again.
They set a fairly impossibly high bar.
That's exactly right.
Next one: Microsoft.
I have mixed feelings about
. I've actually done very well with that.
You do have a position?
Oh, yeah. It's in the top half of the portfolio. What have they got: $27 billion in cash. They have one of the most lucrative business models ever, right? In the gross margins of 90% like other software companies, but there's very little cost in producing that revenue, it's really pretty amazing.
And the problem is, the bulk of their revenue still comes from products that are tied to the PC, and it's hard for them to raise growth rates there, so that's the negative part. I think they may end up doing well on the legal thing, and probably some of that's in the stock, but I think people will be relieved if it's clear that Microsoft is going to be essentially unscathed.
They have essentially the same management, they've got phenomenal market share, they are probably not going to grow 80% to 90% a year like they did in the past. But they have that X-box thing coming out. There's a chance that's going to be successful and open up new markets for them.
What about Intel?
does have its work cut out for it. For the first time in a very, very long time it has real, sustained pressure from
The biggest problem for Intel is really on the manufacturing side. They've got to transition to Micron process technology, because otherwise, this P4 thing is not going to make them enough money.
So, in the short run, it looks like their gross margins are going to go down in the mid-40s range. The solution, which is why they said they were going to spend $7.5 billion on capex, is they have got to get this thing transitioned. If they do that, they will be able to have continued high-growth margins on the core products, and they should be all right.
How about a company that everybody sort of said was going to weather the storm well: EMC?
Well, I think
has weathered the storm well. Now, if by weathering the storm well, you mean no water comes on deck and nobody gets splashed, well, come on.
You want that kind of weathering the storm well? Stay in the car, with the windows rolled up. If you're going to be out at sea and you're in the storm, to me, weather it well means the mast doesn't get blown down, you're not turned over in the boat.
So these guys are getting water over the side because business is slowing, there's a lot of price competition, because their competitors don't want to go out of business. But I don't think their problems are because
come out with a fundamentally superior product, and so is taking market share for secular reasons. I don't think that's happened.
I think they are going through an economically difficult period not of their own making, and we want to continue to own them.
Every investor, professional or amateur, always laments missed opportunities. What do you think people are missing today that they may kick themselves for later?
I don't know. Those are tough questions to answer.
I think that one of the things that people always do is always write off the semiconductor industry because it gets so bad, they just can't take it any more. But I think that it's a tremendously powerful industry. It's been among the most cyclical in all of technology, and so there's a danger in getting too discouraged.
I think the fact that many are throwing the towel in on the communication-semiconductor companies is probably a good sign. I think that it would be a mistake to not own the really top-quality communications semiconductor companies like
10. If you had to buy three stocks and hold them for five years, no questions asked, what would they be and why?
Herskovitz: Well, one company I would mention which is probably not on a lot of people's radar screens is Taiwan Semiconductor. I don't know how widely it's appreciated outside of professional investors, but there is a massive shift in the entire semiconductor industry business models.
The first generation of semiconductor companies all were vertically integrated, meaning that they designed a chip and manufactured and sold them that model for Intel and
That was the model. You designed a chip, and you had to build the factories to make your chips, and then you sold them.
Virtually all the new generation semiconductor companies are fabless. They design the chip, they sell the chip, but they don't have the time or the desire to build a factory. That's all being outsourced.
The dominant company getting that outsourcing is Taiwan Seminconductor. It's an extraordinarily profitable company. Right now it's struggling because its capacity and utilization is probably down 50%. But over kind of a normalized basis, this is one of the most profitable manufacturing companies on the planet.
They've been averaging net margins, after paying taxes and everything, of over 30%, which, for capital-intensive manufacturing companies, is mind-boggling.
So that's one where there's a secular, very long-term, profound secular trend benefiting them, they're the dominant company.
I still like
; the question there is fiber channel. Is fiber channel going to remain the dominant network architecture? If you're super-dominant in a fast-growing sector, you could do very, very well.
. I think it's a very good business over an entire cycle, and they are by far the dominant company.