Going geek - Is tech a good bet for investors?

Donal Curtin

Monday 2nd October 2006

In March 2000, BT Funds Management launched a new unit trust. It was called 'Time', and aimed to invest in the then booming technology, information, media and e-commerce sectors. The launch price was $1 a unit. That very month, on 24 March 2000, the tech-dominated Nasdaq share index closed at a record level of 4,963.03.

And then things turned to custard. In the next few days the index dropped like a stone. It fell almost 350 points on 3 April alone. By the end of April it was over 1,000 points lower, by the end of the year it had lost another 1,400 points, and the rout continued throughout 2001 and 2002. It didn't reach rock bottom until 9 October 2002, when the Nasdaq closed at 1,114.11, which was a total drop in value of over three-quarters.

The consequences for Time were, naturally, catastrophic. Today (going by the latest price on the BT website) your Time unit is worth 24.8 cents. Over the past six-and-a-bit years, the fund has lost 18.7% a year. Other than observing that floating the Time fund at the very peak of the tech bubble wasn't in hindsight the most sensible business decision BT ever made, there's not a lot of point in bagging BT for Time's performance: they and many others were simply overwhelmed by a tsunami. If you bought tech in 1999 or early 2000, you got hammered.

All of this is by way of background to the articles elsewhere in this issue noting the positive outlook for software businesses. Part of your brain may well be saying, "where can I get a piece of the action?" And the other part may be wondering why anyone would be damn fool enough to burn their fingers twice. Here's a guide to some of the issues.

First of all, it is clear that the mania period is well and truly over for tech stocks as a whole. As noted, the Nasdaq bottomed out at less than a quarter of its peak value, and that was similar to the scale of the shakeout that was needed after the other two great share manias of our time (the New Zealand market up to 1987 and the Japanese market up to 1990). It's well past the 'bust' phase and at its current 2,060 or so it's some 85% up from the pits.

But that doesn't mean it's become a nice, orderly market, suitable for the proverbial widows and orphans. It may be off its knees, but it's still very choppy. Between the middle of April and the middle of July, the Nasdaq dropped 15%. AMD, the 'we try harder' competitor to Intel in the chip market, has halved in value this year. If you're going to give it a go, you'd better be very comfortable with the volatility risk.

And you'd better be very, very, very comfortable with risk if you want to go the DIY route and pick your own tech stocks. Tech as a whole may not be overvalued anymore and many tech companies have gone from still-to-be-validated business models to successful companies (EBay and Amazon are good examples), but there are still some pretty fancy valuations around at the individual company level.

Maybe it's right that Google should be valued the same as IBM (they're both worth US$115 billion). Maybe it's right that you're paying nearly four times as much for a dollar of Google's profits than you're paying for a dollar of IBM's (Google's price-to-earnings ratio is 55.5, IBM's 14.2). Maybe it's correct that the page people use to find things can be the base for squillions of ad revenues. Maybe it's smart for Google to pay News Corp US$900 million merely for the right to advertise on News Corp's MySpace internet community. Maybe I don't 'get it', as the tech geeks say. And maybe Google is the biggest screaming sell you've ever seen, vulnerable to the next smart guy with a better search algorithm or cooler marketing.

For me, I like the tech story for its high growth potential, but I'd take some risk out of the equation. Unless you're an industry insider and really know what you're doing, I'd avoid the DIY route and invest via a managed fund. I'd also make sure I had exposure to tech broadly defined, and not just the trendy internet stories: you can easily find funds that cover the biotech and pharmaceutical sectors as well. And I'd be tempted to use funds that are free to stay on the sidelines when they can't find good tech ideas to buy, or even actually short (in other words, bet against) companies they regard as overvalued. You might think that's obvious common sense, but most equity funds do neither: in the tech space, you need both.

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