SuperStar Funds

Hot new tech funds - should you buy? By Paul B. Farrell, CBS.MarketWatch.com Last Update: 1:48 PM ET Oct 20, 2000 NewsWatch Latest headlines LOS ANGELES (CBS.MW) - October massacre. The big, bad bear bites. Investor's Business Daily calls it the "Worst Nasdaq Market Since 1973-74." Down almost 40 percent. The worst in 27 years! The Industry Standard concluded: "Unlike last spring, when the Nasdaq composite fell 38 percent from its record high of 5132, the technology sell-off this time isn't being driven by investor panic, but by a broad and uncompromising effort to measure stocks against companies' financial performance ... earnings are falling far short of the growth executives had promised." Yep, we got an October massacre alright. The latest Technology Investor magazine agrees: "2000 has not been the best year for technology mutual funds ... 51 of 154 technology funds have negative year-to-date returns through August ... the spigot of inflows has dried up." Are new tech funds beating old fogies? Nevertheless, Technology Investor, one of the best new magazines covering the field, ran a glowing article about new tech funds recently, noting that "the number of technology mutual funds keeps growing. Since November 1, 1999, more than 41 new technology funds have opened." In fact, 12 of the 41 new technology funds had impressive year-to-date returns between 25 percent and 122 percent. No wonder the article was titled: "Young Gun Tech Funds Earn Their Spurs," complete with a picture of a real cute, smiling baby. That many hot new tech funds is refreshing in the middle of this October Massacre, right? Wrong. A rather high percentage -- almost half -- of these new funds actually have negative returns year-to-date. Moreover, the remaining winners will soon lose their advantage because the higher returns that new funds have over mature ones only lasts for 18 months on average. So, buy'n'hold investors are well-advised to stick with mature funds, ones that have been around for a while, like Invesco Technology Fund (FTCHX: news, msgs), T.Rowe Price Science & Technology Fund (PRSCX: news, msgs), Fidelity Select Technology (FSPTX: news, msgs), Firsthand Technology Value (TVFQX: news, msgs)), Northern Technology (NTCHX: news, msgs), and even tech-heavy White Oak Growth Stock (WOGSX: news, msgs). All with solid track records. Tricks new funds use to lure you in So what's wrong with new funds? New funds actually plan to lose their edge within 18 months after launch. That's right, studies by Morningstar and others agree. For example, citing a Charles Schwab study, Investors Business Daily concluded: "Much of the out-performance took place in the first six months of the fund's life and disappeared entirely after 18 months." Afterward, new funds melt into the average. Here's eight little tricks used by new funds: Managers work harder. Hey, they gotta prove themselves, fast. But once they see the game's working, they can slack off. Early home-runs score big. Early on, a few successful buys on a small asset base have a big impact. But as assets grow, a single home-run has less effect. Fee waivers. Once a fund starts performing, waivers disappear. Remember, one percent on a $1 billion fund is $10 million! That's what a manager wants. Lower expenses. You want a free ride forever? Forget it. Front-end discounts are just a way of jump-starting a fund's assets by pulling in new money. Low cash reserves. Redemptions are obviously low, so new funds are fully invested, with higher return. Later, higher cash ratios drag down returns. Marketing and public relations. If early returns are hot, journalists descend like vultures, depleting a manager's energy. Size limits investment choices. A small new fund can be flexible in picking stocks of all sizes. The more assets a fund attracts, the tougher it is to find deals. Competition increases. New funds often succeed because they target market inefficiencies. Money rushes in. Returns soar. Then, competition increases. Size limits pickings. Deals get scarcer. And the advantage disappears. Remember, most of the superior performance takes place in the first year and a half after launch. After that, it'll melt into the average. Are new funds a trader's play? Buy. Ride them up. Dump them. Warning, don't play this game. You'll get burned. Remember, aside from the fact that 19 of the latest crop of 41 new tech funds are in the red this year, the fact is, most investors cannot time the market. So it's a crap-shoot. Stick with proven winners with long-term track records. Tips, if you insist on buying new funds If you are going to buy a new fund, bet on new funds backed by solid fund families and managed by experienced managers. Here's a couple tips on minimizing your risks: Family values. "Successful new mutual funds are also often logical outgrowths of more established" fund families and their manager's experiences. As a result, one major "characteristic of successful new funds is that they can rely on a support structure that will be in place long after the initial excitement has faded." Family trust. And "One way to spot a good fund is to look at the track record of the parent company. Fund families with consistently strong performance tend to have strong research staffs." New funds aside, there are some strong signs that we may have hit a bottom in the market. Maybe the key benchmarks could go lower. Maybe not. Maybe we're on the leading edge of a recovery and the return of the bull. I don't know. Nobody knows when the market will make a definitive turn. The real question is: Should you be in tech, or not? You bet! For example, another recent IBD article about "vulture" funds -value funds with cash reserves - gobbling up stocks at bargain prices. Like Marty Whitman, the tight-fisted manager of Third Avenue Value (TAVFX: news, msgs), a fund up 16 percent this year. Increased bottom-fishing is sure sign of a recovery. So, got cash? Check out those tech fund old-timers!  Paul B. Farrell, author of "The Winning Portfolio" and three books on online investing, has been executive vice president of the Financial News Network and an investment banker with Morgan Stanley. He holds a doctorate in psychology and a law degree.