When Kenneth G. Mertz II launched the
HomeState Year 2000 fund on Halloween 1997, the market prospects for Y2K stocks seemed to glow like a jack-o-lantern. The prospect of corporate America spending hundreds of billions of dollars to fix its computer systems meant tall revenues and soaring stock prices for the companies providing such services.
But more than a year later, the fund's performance is looking scarier than a slasher flick. In 1998, the fund gained 2.1%, a sliver of the S&P 500's 28.6% rise and the 53% average gain of science and technology funds tracked by
. This year, the HomeState Y2K fund has fared even worse, falling 8.7% -- placing it dead last out of the 95 science and tech funds in the Lipper universe. To make matters worse, the fund has a 2.9% sales charge and an annual expense ratio of 2.9%.
Some analysts suggested the fund was a good idea executed too late. "Wall Street is always looking forward, not backward," says Bob Austrian, an analyst with
who has tracked the Y2K bug's impact on the software industry. "Most of the services companies' demand peaked in 1998 and therefore their stocks began to do badly in 1998."
In general, Wall Street has punished Y2K stocks on the notion that these companies are cyclical plays that don't hold solid long-term earnings potential. "The marketplace discounted the earnings potential quicker than we thought," explains Mertz. "We were hoping for better results. It didn't quite meet our expectations."
The $9 million HomeState Y2K fund invests in 44 different stocks. Among the fund's top holdings, some of the biggest drags have been
, down 58.1% since it topped on March 24 last year,
, down 64.5% since it peaked Aug. 19 of last year, and
, down 53.8% since it peaked July 8 of last year.
The HomeState Y2K fund is one of three funds managed by Mertz. The former chief investment officer for
Pennsylvania's State Employees' Retirement System
, Mertz also manages the
HomeState Pennsylvania Growth fund and the
HomeState Select Banking and Finance fund. The growth fund has averaged a respectable 16.8% annual return during the last six years, while the banking fund, which has only been in existence since February of 1997, fell 20.6% last year.
Both the Y2K fund and the Growth fund share several of the same stocks among their top holdings.
, two of the Y2K fund's top five holdings as of Sept. 30, 1998, are in the top 10 holdings of the Growth fund, according to
, two of the Growth fund's top five holdings as of Dec. 31, 1998, are in the top 25 holdings in the Y2K fund, according to Morningstar.
"We use a lot of the same small-cap companies," says Mertz. The prospectuses of his other two non-Y2K funds say the management likes to invest in companies with strong balance sheets and dominant or leading positions in niche markets.
Mertz does have some wiggle room. The prospectus of the Y2K fund says that the fund invests at least 65% of its assets in Y2K companies, which potentially leaves up to 35% of the fund's money for other companies or U.S. government securities and short-term debt.
Some Y2K analysts are not wowed by Mertz's selections. "It seems to me that the fund manager is not doing a very good job of picking the companies," says Kazim Isfahani, a Y2K analyst with the
Giga Information Group
. Isfahani suggests looking at companies that provide Y2K tools and solutions like
, instead of service providers that essentially sell the labor of software engineers. But Mertz says they underweighted tools companies because a lot of service firms were using their own tools or fixing their own code. "Those companies also performed very poorly," he adds.
Then again, even if Mertz had diversified his portfolio of Y2K stocks, some mutual fund experts question the value of a specialized industry fund.
"It makes sense to sell it," says Sheldon Jacobs, editor of the
No-Load Fund Investor
, a newsletter published monthly since 1979. "It doesn't make sense to buy it. As a serious investment, I just don't see it."
Specialized industry funds, says Jacobs, are "basically all marketing gimmicks" that should only be bought by people with fundamental knowledge of the industry. "People start these industry funds after the industry has had a decent rise," he says. "When you buy an industry fund, there's a real good chance that you're buying it at the top."
Mertz says his current research indicates that the fund stands to benefit from a Y2K-induced uptick in the replacement market for desktop computers. As such, in the last few months he has loaded up on
. "This trend is still very strong," he says. However, PC unit sales have showed weakness of late, dropping 28% from December levels, according to
analyst Steven Milunovich.
Perhaps that's why Mertz is considering a shift away from Y2K plays. As the Y2K problem peters out, Mertz says he is thinking of broadening the scope of the fund, possibly before the end of the year. "The most logical thing to do is to turn this into a broader technology fund," he says. To do that, Mertz says he must file a prospectus change with the
Securities and Exchange Commission
and obtain shareholder approval. If he chooses to pursue this path, Mertz says he doesn't anticipate any problems.
Asked if he thinks the Y2K fund is a success, Mertz calmly replies, "I think the jury is still out."
April 15 is fast approaching. For some insights that may help you with your return, read our series, TSC Does Mike Bauer's Taxes. Yes, we really do a reader's tax return to illustrate how tax laws apply to real people. And join the author, TSC tax reporter Tracy Byrnes, and Martin Nissenbaum of Ernst & Young for a Yahoo! Chat Tuesday at 5 p.m. EST.