Tech From Top to Bottom
Aug. 27, 2003 — After more than three years of steep declines, tech stocks have rebounded this year. Most funds that invest exclusively in tech have delivered returns of 30%, 40%, 50%, or even higher. Through the end of July, the tech-heavy Nasdaq has gained 29.9%, versus 12.6% for the Standard & Poor’s 500-stock index.
The $49-million Hartford Global Technology Fund/A (HGTAX) has paralleled the performance of the overall tech sector. After incurring losses in 2001 and 2002, the fund has surged 32.6% this year through July. For the three-year period ended July 31, the fund lost 25.8% annualized, versus a 30.6% drop for the average tech fund.
Launched in May, 2000, two months after the tech/telecom meltdown, the portfolio is managed by team of global analysts at Boston-based Wellington Management. Each member focuses on a specific subsector within technology. Scott Simpson serves as the fund’s “portfolio coordinator,” while John F. Averill, Vikram Murthy, Bruce L. Glazer, Eric Stromquist and Anita M. Killian round out the management team.
As it stands now, the underlying causes behind the resurgence in technology have come under debate. Some believe that fundamentals for the sector have finally turned bright, while skeptics contend that sales remain tepid, and profits have been propped up by a weak dollar.
Simpson cites three factors behind tech’s rebound this year. The first is that tech stocks overshot on the downside, more than discounting how bad things really were. Secondly, and more importantly, are signs of stabilization in certain subsectors he has seen, as well as an improved outlook for the broader economy. Finally, as capital spending increases, “tech should be a primary beneficiary.” However, Simpson cautions that tech is unlikely to ever deliver the growth rates seen in the late 1990s.
The fund’s portfolio is typically concentrated with heavy weightings on favorite holdings. As of June 30, the portfolio comprised 44 stocks. The ten largest holdings as of that date were Cisco Systems Inc. (CSCO), 8.2%; Microsoft Corp. (MSFT), 7.9%; First Data Corp. (FDC), 5.9%; International Business Machines Corp. (IBM), 5.1%; Dell Computer Corp. (DELL), 4.6%; Cendant Corp. (CD), 3.9%; Analog Devices Inc. (ADI), 3.6%; Maxtor Corp. (MXO), 3.5%; Nokia Oyj (NOK), 3.4%; and AOL Time Warner Inc. (AOL), 3.1%. The ten top stocks accounted for nearly half (49.2%) of the fund’s assets.
The fund has a median market cap of $8.3 billion, but Simpson is free to invest without regard to market-cap size. “Larger-cap stocks have lower risks, while smaller-cap stocks provide higher growth prospects, although much higher risk,” he noted. “The size of a holding reflects its risk-reward profile, and our conviction in that company.”
Although individual stocks are selected on a purely bottom-up basis, Simpson’s team look at top-down elements to determine which subsectors within tech are posed to outperform or weaken. The fund weathered the difficult climate in 2001 and 2002 with an overweight position in tech services stocks as a defensive measure. “We focused more on risk than reward,” said Simpson.
The fund’s two largest subsectors are currently technology hardware & equipment (37%), and software & services (32%). “In the last three quarters, the software industry, in the aggregate, has posted modest growth in sales, but this still represents a turnaround after three years of double-digit declines,” Simpson explained. “There are reasons to believe the worst is behind us, but much depends on how much the economy recovers.” The managers have been shifting more money into software stocks.
Simpson is particularly bullish on the semiconductor industry, on a top-down basis. “There has been limited capital investment in this business the last few years,” he said. “But amidst an improving economic outlook, a healthier supply-demand picture should emerge for semi and capital equipment companies.” Internet and e-commerce stocks are other areas where Simpson is seeing more opportunities. “Increased online advertising has been quite encouraging,” he noted.
The fund strives for diversification across tech as a risk-control measure, Simpson added. However, no maximum nor minimum constraints are imposed on how much a subsector can represent in the fund. Simpson and his team are quick to pull the plug on a stock, but turnover is not something he worries about. When a stock hits its price target, or the investment premise changes, they will sell. Their goal is to remain fully invested at all times.
Simpson conceded that to sustain high valuations, tech stocks will have to deliver robust earnings growth. “Recovery has been discounted into the prices of tech stocks, and we need follow-through on the fundamentals,” he said. However, he believes earnings growth will be strong over the next several quarters. “For investors, stock selection will be critical,” he added. “The gap between the haves and the have-nots is growing.”