Feb. 26, 2004 — Waddell & Reed Advisors Science & Tech/A (UNSCX) seeks to capitalize on scientific and technological innovations while avoiding market overreactions to those changes. “We look for companies that are changing and are being changed by new sciences and new technologies,” said manager Zachary Shafran.

To avoid market overreactions, the fund focuses on science, as well as technology, to diversify beyond a strictly tech concentration. The fund is also willing to have a sizable cash position. In addition, the $2.1-billion portfolio gains stability with a median market cap of $6.4 billion, larger than many tech funds.

These strategies and characteristics have helped moderate the fund’s volatility. The portfolio’s standard deviation of 18.29% trails the 41.90% average for technology funds, owing in part to the broader definition of technology.

Shafran says moderating volatility, particularly through a dual science and tech focus, is a key reason for the fund’s long-term returns: It is the second-best performing technology fund for the ten years through January. Over that period, the fund rose 16.8%, on average, trailing Select Electronics (FSELX), which had a 19.4% gain. Technology funds were up 10.6% for that time, while the S&P 500-stock index rose 10.9%. Sizable cash stakes in 2000, 2001, and 2002, helped the fund outperform, according to Shafran, who took over the fund in February, 2001.

This emphasis on cash, however, recently lessened the fund’s returns. For the one-year period through January, the fund was up 41.2%, versus a 63.2% gain for the average tech fund. In 2003, the fund’s cash stake was about 23%.

Historically, the fund has focused on information technology and health care because of the growth potential, and because companies in those industries “can regularly reinvent themselves,” Shafran said. The fund’s sector positions currently are about 65% in technology, and about 35% in health care. The manager likes information technology because of increased capital spending, and health care because of demographic changes.

In addition to sector concentrations, the fund’s top-ten holdings typically make up about one third of the portfolio. Total holdings generally range from 45 to 65 stocks. At the end of the last year, the fund’s top-five holdings were Research in Motion (RIMM), HCA Inc. (HCA), Xilinx Inc. (XLNX), Cerner Corp. (CERN), and Boston Scientific (BSX). Shafran likes Research in Motion because companies are boosting information technology spending.

Shafran looks for companies with 20% annualized top-line and bottom-line growth for the next three to five years. The manager avoids highly leveraged companies.

The fund’s investment strategy is primarily bottom-up, but Shafran considers themes to cluster holdings. “When you find a good theme, you typically don’t find just one company,” Shafran said. The manager is currently considering wireless technology for investment, seeing opportunities in the convergence of wireless and online technologies.

Shafran applies his investment criteria to both domestic and foreign stocks, with the latter usually making up about 20% of the fund. For international stocks, Shafran also considers geopolitical factors. Current international holdings include Nortel Inversora SA (NTL) and Samsung Electronics (SAME).

– Bill Gerdes