Money: Tech wrecks blow a fuse

By BRENT SHEATHER

The stockmarket is full of ironies. One of the better ones is the fact that when everybody loves one sector that is usually precisely the best time to sell.

So it was with emerging markets funds in 1993, and it looks to be happening again with last year's favourite, technology stocks.

Since the Nasdaq index, the best-known measure of US high-tech stock prices, peaked in early March of this year it has fallen 45 per cent, compared with a drop of only 3 per cent in the broader US market.

One dead giveaway that times were too good was the multitude of specialist technology funds which investment bankers were falling over themselves to launch, not to mention the fact that about one quarter of Australia's mining companies re-invented themselves as high tech operations overnight.

Investors in closed end funds - a type of pooled investment which is listed on the sharemarket - were offered another useful hint that markets were over-hyped: most of the popular technology investment trusts were trading at as much as 20 per cent more than their intrinsic value, whereas 12 months or so earlier they could be bought at discounts of up to 30 per cent.

Shades of 1993, when most emerging market funds were selling at premiums. Those same funds now languish at big discounts.

Of course no one doubts that technology will continue to drive the world economy and its stockmarkets in the long term, but some mum and dad investors must have got quite a shock recently when they saw their XYZ tech fund, which could previously do no wrong, falling by up to 5 per cent in a day.

This sort of volatility can give the stockmarket a bad name and is why intermediaries like stockbrokers and financial planners need to exercise caution when making big bets on a particular sector with their clients' money, especially if those clients are relatively short-term investors.

Unfortunately that is not the way the game is played.

Salesmen and women are always looking for an angle, and the biggest game in town has been flogging the promise of techno-riches to the masses.

Brokers, fund managers, financial planners and investment bankers love initial public offerings of high-tech firms and specialist tech funds with hefty expenses, paying 3 per cent commissions and ongoing fees.

Unfortunately, the riskiness of many retail investors' portfolios looks likely to rise as volatile new-age "thematic" investment strategies increase in popularity and replace old-fashioned geographic diversity. It makes one wonder what clients pay investment advisers for most - to find bargains or filter out the fashionable?

Intermediaries, particularly those advising people saving for retirement, need to appreciate that investing is not a game where it doesn't matter too much if you get it wrong.

Many people have only a short period in their lives when they will have extra cash for investment, and concentrating their money in one sector is asking for trouble, particularly if everyone is selling the same story at the same time.

One of the favourite plays for technology devotees has been a stock called QQQ. This is an investment trust which owns shares in 100 companies listed on the Nasdaq; by buying QQQ shares, investors have a stake in those companies without having to buy 100 individual stocks.

That convenience has helped make QQQ one of the most heavily traded stocks on the US exchange.

Investment banks also like QQQ because in times of great demand these "tracker stocks" tend to trade at a small premium over their underlying value. So, the institutions which form the QQQ units by buying the underlying stocks can earn extra fees when they sell those units for more than they cost.

But there is no dividend income to support QQQ's returns in bad times and no dividends look likely for quite a few years yet. That leaves investors dependent on fickle capital gains.

If you buy shares across the broad spectrum of the US stockmarket, even if you make a bad call you at least have a small dividend to console yourself with.

Investors buying into the technology story - above and beyond the high-tech investments they would make anyway as part of a "neutral" strategy - need to understand that they are making two critical assumptions:

Technology has a higher growth outlook than other sectors of the stockmarket.

This is not already reflected in share prices.

Until recently, even the high-tech sector's critics conceded that technology had outstanding growth prospects.

Where a real leap of faith is needed, however, is the belief that the market as a whole doesn't appreciate this fact, and hasn't already built it into prices.

As technology stocks represent one-third of the US stockmarket and most brokers these days seem to devote half of their research teams to analysing their every move, this seems unlikely to say the least.

But buying funds wasn't the best way to get burned by the technology mania. It was possible to lose much more money by investing in individual New Zealand and Australian tech plays.

As the table below shows, local stocks IT Capital and Advantage have managed to fall by 72 per cent and 74 per cent respectively since the Nasdaq peaked.

Solution 6 in Australia is down 88 per cent and still heading south. And BTs technology unit trust, launched with much ado, has managed to fall by 28 per cent despite the kiwi dollar dropping like a stone over the same period.

Investors would have been better advised to stick to more diversified portfolios as owned by some of the old favourite UK investment trusts like Foreign & Colonial (up 10 per cent), Fleming Overseas (up 5 per cent) and Bankers Investment Trust (up 11 per cent).

Many local brokers have advised clients that the safest way to get technology exposure has been via direct shareholdings in the leading names such as Cisco, Microsoft, Oracle and MCI Worldcom.

For all but the very largest private investors, such advice is naive, because it ignores the fundamental strategy of spreading your eggs over many baskets and, more dangerously, assumes that your broker can pick winners for you.

Even the biggest names in the high tech world have suffered badly, as the table illustrates.

So what burst the technology bubble? There is a simple answer: growth, or rather a lack of it.

One of the biggest things driving stockmarkets in the 1990s, and tech stocks in particular, has been the ability of some companies to increase their sales and profits much faster than the economy as a whole, often by exploiting technological advantages. What has changed lately is that many of these high flyers have warned that their profit growth was not going to be as great as the market had expected. As a result, prices fell.

Compounding the effect of growth downgrades has been a great rush of new equity and debt being issued by telecommunications companies in particular. While global stockmarkets could not get enough exposure to the telecommunications business 12 months ago, today even blue chip companies like Deutsche Telekom are having trouble selling debt.

Overlay this with the fact that investors' appetite for risk appears to be on the decline and, hey presto, your tech stock just fell 30 per cent.

Warren Buffet hit the nail on the head when he suggested around the Nasdaq's peak that all business school students should be asked to do a paper justifying internet company valuations - and that any who attempted it should be failed.

* Brent Sheather is a Whakatane sharebroker.