Internet funds: shaken, but not deterred

Weak dotcoms are fading fast, but the Web's overall growth means long-term opportunities

Bob Grandhi felt as if he had been given a live "hand grenade."

On April 1, the India-born analyst took on the job of portfolio manager of Monument Internet Fund, just after the price of Internet stocks started a huge plunge.

Mr. Grandhi is not alone in his dread at seeing the hot Internet stocks plunge into icy waters. So are investors in some 34 other Internet funds in the United States.

Most were created in the second half of 1999 or early 2000. Fund groups sought to exploit the explosion in demand by investors hoping to participate in the spectacular returns of that technology sector in 1998 and last year.

There were only four Internet funds at the start of 1999.

Price charts of some latecomer funds show a modest upturn at the start of this year, and then a line downward like the path of a diver in the local pool. Splash!

"A lot of folks lost half their money in a space of two months," notes Christopher Traulsen, an analyst at Morningstar Inc., a Chicago firm that ranks mutual funds.

Investors who put $1.9 billion into Merrill Lynch Internet Strategies, for example, were not happy to see their shares drop from $8.61 soon after the fund got started on March 22 to a low of $5.45 in late May. They have bounced back since then to around $7.36.

In the case of Monument Internet, shares in the Bethesda, Md.-based fund rose rose 273 percent in value last year. It was the highest-ranking fund invested in Internet stocks, and fifth among all stock funds, according to Morningstar.

But the manager at that time, Alex Cheung, left for greener fields. Mr. Grandhi was brought over from Daiwa Internet Industry Fund, an offshore fund whose shares were sold to Japanese investors. There he had been an advisor to the manager.

By the end of June, Monument Internet Fund shares were still down some 20 percent for the year, despite a June rally in some Internet stocks. "I am hanging in there," says Grandhi.

Morningstar analysts are extremely cautious on Internet funds. After all, two of them are among the worst performing stock funds this year. Shares of Potomac Internet Plus fell 44 percent through the end of June. The fund is leveraged so that it benefits especially from rising Net stocks, and vice versa when these stocks take a nasty turn. Jacob Internet is down 41 percent.

Morningstar's Mr. Traulsen calls "the Net-fund craze a minefield of inexperienced managers and high expenses." He suggests that investors may be better off putting their money in technology funds that invest only a portion of their money in Internet stocks.

Grandhi admits that Net stocks are highly volatile in their price. But he says he is "confident we will get a rally."

Traulsen cautions that trying to time such a rally is difficult, if not impossible, and that Net stocks are still expensive relative to the rest of the stock market.

But if an investors is determined to take the risks of Net funds, he points to two with more established management.

One is RS Internet Age, comanaged by James Callinan and Cathy Baker. It is down only 1.4 percent for the year.

The fund is run by RS Investment Management, formerly Robertson Stephens Investment Management, a San Francisco-based boutique investment firm focused on small-to mid-sized companies, especially those in the New Economy. It manages some 11 different funds with more than $8 billion in assets.

When NationsBank bought Bank of America and Robertson Stephens, the mutual fund management team negotiated a buyout from the bank, a deal that closed early last year.

Last January, Mr. Callinan was named Domestic Fund Manager of the Year by Morningstar for his management of RS Emerging Growth Fund

"Its experienced managers give it more appeal than most other Internet offerings," says Morningstar. It also doesn't have an up-front sales charge, unlike many Internet funds.

The other fund is Goldman Sachs Internet Tollkeeper, managed by a team at the famous New York banking firm. It is down 3.8 percent so far this year.

H. Bradlee Perry, a consultant with David L. Babson & Co., money managers in Cambridge, Mass., suggests that investors wanting to put money into this "risky and speculative" Internet area should do so on a "dollar-cost-averaging" basis - putting in some money every month rather than all at once. This spreads the risk somewhat of losing money fast should Internet stocks suffer another market wreck.

Many Internet companies, he suspects, will not survive the shakeout in the industry. That's especially true of firms providing retail services to consumers.

Even those firms aiming at providing services to businesses may find that customer companies set up their own networks, and no longer need their services, Mr. Perry adds.

"One key problem is that venture capitalists have thrown too much money at Net companies," he says. "Idiots can get money. But competition is a powerful force. It weeds out the weak."

Already some Internet companies are finding that getting a second or third infusion of capital is difficult, if not impossible.

For example, New York-based APB Online, operator of a criminal justice news Web site, said last week it would file for bankruptcy after it was unable to find investors to inject new capital into the money-losing firm.

Over the longer run, Internet stocks are expected to benefit from the high growth of the industry. A new survey of corporate chief information officers by CIO magazine and by Edward Yardeni, chief economist in New York of Deutsche Bank, finds that their companies - with information technology budgets of $50 million or more - plan on average to boost spending on information by almost 20 percent this year, with one-quarter of those budgets devoted to Internet commerce.

There is no significant slowdown in information technology spending this year. That's opposite to what many expected with passage of the Y2K period at the end of 1999, notes Dr. Yardeni.

Panelists surveyed said they expect to purchase on average about 23 percent of their materials, supplies, and parts over the Internet in the next 12 months, up from 14.7 percent in the previous 12 months.

For some but not all Internet companies, that could be good news. It indicates the Internet should remain a high-growth area.

(c) Copyright 2000. The Christian Science Publishing Society

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