Professional managers have always moved like lemmings from one industry to another. But the herd instinct is in danger of getting out of hand, and some Wall Street watchers fear that small investors will be badly burned when the big mutual funds decide to move on. While mutual funds are taking big stakes in many industries, high-tech stocks may be the first place the bubble bursts. “There’s a lot of hot money in technology stocks,” says John Rekenthaler, editor of Morningstar Mutual Funds.
How hot? While high-tech stocks account for just 9 percent of the overall market, some of the nation’s largest and most aggressive mutual funds – such as Fidelity Magellan and Twentieth Century Ultra – have shoveled nearly a third of their portfolios into these businesses. Worse, some experts believe that fund money in tech stocks is creating a speculative bubble that will go down as one of the ugliest on record. “This is going to be like Mexico after the peso devaluation. This will be such a debacle that Congress will decide to investigate,” says Bill Fleckenstein, a principal in Olympic Capital Management, which manages $1.5 billion – some of which is betting against technology stocks.
That may be a bit extreme, but the tale does seem eerily familiar. In the waning days of the 1972 bull market a strange thing happened. A small group of growth stocks, including Avon, IBM and Black & Decker, continued to soar while the rest of the market fell. Bank trust departments, the heavyweight investors of the day, flocked to the group that was dubbed the Nifty Fifty. “They were one-decision stocks – of such high quality you would never have to make the second decision, to sell them,” recalls Peter Bennett, a portfolio manager with State Street Research in Boston. Still, the Nifty Fifty stumbled badly when earnings declined. These Blue Chips joined the rest of the bear market of 1973-1974, and it took an additional 10 years before the Nifty Fifty’s stock prices returned to their 1973 peak.
Twenty years later this scenario seems to be playing out once again. But this time the never-fail stocks belong to the technology sector. Wall Street’s heavyweights – this time the big mutual-fund companies – are piling into a narrow group of stocks that seem infallible. And they’re breaking all kinds of old-fashioned investment rules to do it.
Jeff Vinik, manager of Magellan, is clearly king of the monster position-takers. As of Sept. 30, he owned 7 percent or more of Altera, Atmel, Dell Computer, Micro Warehouse, Sybase and 3Com, to mention a few of the technology names that dominate his $36 billion fund. Nearly half of his portfolio is made up of stocks in which he owns 5 percent or a bigger stake of the company. Vinik has a ready answer for the charge that he’s developed hazardous habits. “I don’t agree that it’s risky,” he says. “At this time I am bombarded with what I think are terrific investments in companies with outstanding prospects and cheap valuations.”
Another giant who’s bingeing on technology: Twentieth Century Ultra, which had nearly 28 percent of its $9.7 billionin such large, mostly technology-oriented, positions at the end of October. Is it risky? Yes, admits Robert Puff Jr., Twentieth Century’s chief investment officer. “Butwe are paid to evaluate risks and we’re comfortable.”
What happens to stock prices when a behemoth starts nibbling at a mouse? Take Atmel, a chip maker based in San Jose, Calif. Fidelity’s Magellan owns 4.5 million shares, or 10 percent of the company. Even if Vinik had spread his purchases evenly over three months, he would have had to buy 50,000 shares a day – about 10 percent of the stock’s daily trading volume. In the old days, that slight increment – and the resulting increase in the stock price – might have gone unnoticed. Not these days. A new breed of buyer – called a momentum investor – now responds immediately to stocks with a rising price and growing trading volume by jumping in. The result: from $9 a share in April of 1993, Atmel has soared to $34 a share, after splitting last spring. It may not seem sensible to buy a stock just because it’s moving up, but riding a high flier’s coattails has been a spectacularly successful strategy in recent years, attracting legions of new practitioners. “The amount of money controlled by momentum players has grown twice as fast as everyone else’s during the last six years,” says Morningstar’s Rekenthaler.
Now when the funds fall in love, it gets crowded fast. One example is 3Com. At the beginning of 1993, 55 funds owned 5.2 million of the computer-networking company’s shares. Twenty-one months and one stock split later, there were 117 funds with 27 million shares. The stock soared from $13 to $33, split, and rose again, to $49. The pile-on phenomenon is causing managers to pay some amazing prices for stocks. The average stock’s price-to-earnings ratio, a measure of how expensive a stock is, is about 17 today. But the ratio for stocks in which the funds have big stakes ranges from the high 20s up to 85.
The risk, of course, is that instead of signifying how marvelously earnings will grow, these high prices are a flashing yellow light that reads: mass delusion underway. Individual investors could get hurt two ways. If you own a stock that’s been breathlessly bid up this way, you’re vulnerable because the funds will stampede out of these securities at the slightest provocation. Pyxis, a maker of automated hospital equipment once loved by the funds, dropped 27 percent over two days in late October. Its offense? Third-quarter earnings were off by a penny.
If you’re a fundholder, the largest threat is that other fundholders – especially Magellan’s – will cash out. If Vinik had to begin selling some of his giant positions, a mad scramble for the exits would ensue. “There are no secrets on the Street,“says a former fund manager of one of the country’s largest funds. “After the first day, when everybody sees Vinik selling 200,000 shares of Oracle, they’re going to bail out, too, because they know he has 14 million more Oracle shares to be sold.”
What will stop the funds from stocking up on king-size portions? Failure to make money from them. It doesn’t have to be a mutual-fund crisis. A price war, or slowing capital expenditures, might stall tech companies’ growth just enough to bring the funds back down to earth. But the longer the practice keeps working, the harder that trip back to terra firma will be for funds and individual investors. The next time you hear about a hot littlegizmo maker that’s expected to keep growing at 50 percent a year, remember the Nifty Fifty.
Here are some companies whose big owners include mutual-fund firms:
AMOUNT OF HOLDINGS IN PERCENT Company: Altera Corp. (Semiconductors) Funds: Fidelity 9.6% Alger 5.6 AIM 3.2 Company: Atmel (Integrated microcircuits) Funds: Fidelity 14.4% Nicholas-Applegate 5.1 Twentieth Century 3.8 Company: KLA Instruments (Optical inspection equipment) Funds: Fidelity 13.4% Twentieth Century 5.8 Nicholas-Applegate 4.7
