Science and technology funds have been slowly digging themselves out from the debris of the 2000-2002 bear market. While they recouped some of their losses in 2003 and 2004, this year seems to be prolonging the pain as returns have been flat to negative. Still, managers maintain conditions should improve, while they are being selective about prospects that offer better upside.

“The fact it’s gone on for so long is partly because of the hangover from the wretched excesses in the 1997-2000 Internet bubble. There was a huge amount of money chasing after opportunities,” says Robert McWhirter, manager of Northwest Specialty Innovations Fund and president of Toronto-based Selective Asset Management Inc. “You had a lot of players in the telecommunications industry — incumbents as well as new startups. Back in its heyday, there was a ‘gold rush’ with new players who said they could beat the incumbents using fibre optics to carry obscene volumes of information.”

McWhirter argues the telecommunications sector, in particular, has suffered from over-capacity and tumbling prices. Nortel Networks Corp., for instance, has seen its stock plummet, mainly because demand dried up after the boom years of the 1990s. “We’re back to more normal growth rates. It may be another five years before we get to the point where we say, ‘Hey, we have another huge convergence that will create a large demand’.”

But there have been signs of strength. He notes, for instance, that worldwide sales of cellphones may reach a record 700 million units this year, according to a forecast by Forrester Research, a U.S.-based technology consultancy. This spells good news for leading manufacturers such as Nokia Corp. and Motorola Corp. As well, the benchmark Philadelphia Semiconductor Index (known as SOX), which covers 19 chip makers, has gone from 560 in January, 2004, down to 377 in April, 2005, and back up to 465 in mid-August. “There are parts of technology that look gloomy, but other areas, such as semiconductors, are coming back. Technology looks like it is turning a corner. From a technical analysis viewpoint, it is making interesting monthly buy signals.”

He’s been a buyer himself. He has reduced the fund’s cash position to 14% from 35% at the end of April. “We bought a lot of U.S. stocks because we were convinced that a bottom was occurring. The large-cap Canadian names, such as Nortel, don’t look as attractive. So we bought a bunch of U.S. names we think offer better value,” says McWhirter, who blends a quantitative 12-factor model that relies on earnings estimates and subsequent positive or negative revisions with fundamental bottom-up stock-picking.

Running a portfolio of 45 names, which is dominated by large weightings in CAE Inc.,
Telus Corp. and Geac Computer Corp., McWhirter bought Motorola Corp. and Marvell Technology Group, a maker of transceivers and semiconductors used for communications gear. “Like Motorola, Marvell is trading up at a four-year high because people are saying, ‘The outlook is good and it is profitable’.” He paid about US$19.25 for Motorola, which is trading at US$21.40. Marvell, bought at US$34, is now trading at US$43.

McWhirter also likes Itron Inc. A Spokane, Wash.-based manufacturer of sophisticated gas and water meters, it is benefiting from growing pressure on consumers to be more energy efficient. “It’s a fairly easy ‘green’ sale,” he says. Bought at the end of April at US$42, the stock is trading at US$52.

André Desautels, co-manager of CI Global Science & Technology Corporate Class Fund, is also bullish, even though the sector has been going through a difficult patch. “We’re still optimistic on the sector on an absolute basis, and relative to the overall market,” says Desautels, principal at New York-based Trilogy Advisors LLC. “From a macro level, things appear to be relatively OK. Despite some of the headwinds that have come from higher oil prices, we’re still in a period of global growth. And going forward, we think most of that growth will come from capital investment, more so than consumer
spending.”

He maintains consumer spending in the U.S. has been driven by a hot real estate market and aggressive use of leverage by consumers. Yet business spending has been subdued.
“Companies have been very focused on trimming costs. But now they find themselves in a situation where their balance sheets are healthy and they’re holding a lot of cash.”
Looking ahead, he and co-manager, François Campeau, a principal at Trilogy, believe the trend will reverse and there should be better growth on the corporate side.

@page_break@“Technology is the largest component in capital spending: it’s more than 50%, and it has been growing steadily. That secular updraft has not really changed even in the past few years,” says Desautels, adding that his firm is quite positive on certain areas within the sector that should benefit from this trend.

Running a 42-name portfolio, Desautels and Campeau are focusing on wireless equipment spending and access, such as high-speed cable services. They have avoided wire-line telecom providers such as Nortel Networks Corp. Currently, 12% of the fund is in semiconductors, 17% software, 38% hardware and communications equipment, 15% media and Internet-related firms, 6% health care, 8% telecom services and 4% cash. In recent months, they have taken profits in the semiconductor area and reinvested in the media and Internet.

They have reduced the software weighting, as holdings such as PeopleSoft Inc. were taken over and valuations became rich. One exception is Microsoft Corp., which they recently boosted to their top holding. “It has been a serial under-performer,” Campeau says. “The top line has always been good. But we haven’t seen a significant increase in earnings per share because it has been investing in products such as the new Xbox coming out at the end of this year and the new version of Windows, due at the end of 2006.” He expects the benefits will show up in the next two years. Besides, if the firm’s $5 a share in cash is stripped out, it is trading at about the same multiple as the broader market, or 17 times earnings. “This is not a big premium for a company with the quality of Microsoft.” The stock is trading at US$27.50, slightly above the average cost of US$25.

The fund has moved into Amazon.com and eBay Inc., which was lagging at the start of the year. “eBay was down about 40% year-to-date when we bought it in the spring,” Campeau says. “It dropped because it had invested in China and PayPal, its payment system. But we think these investments will get good returns.” The stock was trading at 35 times trailing earnings, which is high, but Campeau argues isn’t high for its kind of growth, “which is 40% earnings per share.” Bought at about US$36, it is trading at around US$41.50.

“We’ve come off the bottom in terms of year-to-date performance,” says Walter Price, manager of GGOF Global Technology Fund and managing director of San Francisco-based RCM Capital Management. Noting the benchmark Nasdaq index bottomed in April at 1800 points and is now 2150, he adds, “What happened in 2004 and ’05 is that people sensed a slowdown in the economy and that expectations were too high. As that gets factored into stock prices, people are asking whether this is a recession or whether growth is re-accelerating.”

But he sees positive signs. First, the semiconductor industry is looking up. “Two-thirds of firms say business improved in the second quarter. That’s encouraging because they provide basic building blocks for a lot of technology players.” In addition, he says the communications sector has relatively healthy cash flow and is spending more on technology to improve client services. Finally, he believes there is continuing growth in e-commerce, whether in advertising or retail sales.”

A growth manager with a bias to lower valuations, Price divides the fund into two categories. There is about 70%-80% in growth stories and 20%-30% in turnaround. On a sector basis, there is an over-weighted 13% in Internet and 30% in semiconductors, versus 10% and 23%, respectively, in the benchmark Goldman Sachs Technology Index.
Conversely, there is an under-weighted 15% in software (19% in the index), 9% computers (21%), 10% communications (17%) and 2% services (8%). A top name in the 65-stock fund is Verisign Inc. The firm runs the dot-com directories and roaming functions for wireless services in the U.S., a business growing about 15% a year. But its high-growth business is Jamster, a subscription content service for cellphones. Bought about a year ago at US$18, the stock is trading at US$23.60. His 12-month target is
US$35, a price it hit last December. IE