Like almost every other sector, science and technology has taken a beating in the past year, largely because of concerns about a global economic slowdown. But fund managers are mixed in their approaches going forward: some are bullish on emerging trends; others favour large-cap companies with good liquidity; a third group remains defensive.

One of those in the first camp is Walter Price, managing director of San Francisco-based RCM Capital Management LLC and co-manager of GGOF Global Technology Mutual Fund, sponsored by Guardian Group of Funds Ltd. “There’s modest growth in the business and consumer world, but it is pretty selective,” Price says. “There is a lot of budget pressure.”

The financial services industry, the largest purchaser of information-technology services, for example, is cutting back.

Price argues that IT is undergoing a two-phase transformation. The first phase revolves around cost pressures forcing the consolidation of data centres. “This allows corporations to improve the efficiency of their operations,” he says. “Most of the costs are no longer in hardware and software but in people.”

The second phase concerns outsourcing maintenance and development of new applications. “That results in very modest growth for traditional hardware and software companies,” Price adds. “You should have selective growth for companies that adapt to that environment.”

Price maintains that this two-phase transformation will lead to a new set of growth companies: “Some are adapting, and will see stable growth through this period. There are others that will struggle through the transition.”

The change could be as drastic as the upheaval caused by the personal computer as it revolutionized the IT world. “There is a fundamental change in how people approach IT and software deployment,” Price says. “It’s driven by a search for a better way of doing things, and a better return on investment.”

A growth investor, Price is focusing on companies that will be beneficiaries of the new environment, such as Cisco Systems Inc. and Juniper Networks Inc., which build communications infrastructures. Another set of promising firms are IBM Corp. and Cognizant Technology Solutions Inc., which will gain from strong demand for outsourcing services.

From a sector viewpoint, about 13% of the GGOF fund’s assets is in Internet firms (vs 10% in the Nasdaq index), 10% is in semiconductors (vs 15%), 14% is in communications equipment (vs 17%), 12% is in computer hardware (vs 28%) and 10% is in software (vs 18.5%); the fund has smaller weightings in areas such as alternative energy and 9% in cash.

One of the top holdings in the 65-name fund is SalesForce.com Inc. The San Francisco-based firm offers customer relationship management services and earns subscriptions from renting software over the Internet. “Companies such as Microsoft Corp. are trying to add services onto their software, whereas SalesForce.com delivers its software as a service,” says Price. “The customers vastly prefer the new way of doing things. They only pay when they use the software.”

Acquired about three years ago, the SalesForce.com stock was recently trading at about 10 times cash flow, which is growing by 40%-50% a year. “It looks reasonable on that basis,” Price says. “SalesForce.com is pioneering a new paradigm of doing business and many people will adopt it.”

The stock was recently trading at US$64.70 a share; Price believes it could be US$100 a share in about a year.

Price also favours leaders in the so-called “smartphone” industry, namely Apple Inc., Research in Motion Ltd. and Qualcomm Corp. (a maker of semiconductors for 3G phones). “The consumer is under stress,” he says. “But there are a few products that have high utility and will continue to sell well.”

Apple comprises 8% of the fund, twice as much as RIM’s weighting. “We thought the iPhone would put pressure on RIM’s stock price, and it did,” says Price. “Now that RIM has corrected, it is quite interesting and has a lot of potential.”

Apple was recently trading at US$156 a share; Price’s 12-month target is US$200. RIM was recently $123 a share, but could be $175 in 12 months.



Ben Rogoff, director of London-based Polar Capital Partners Ltd. and co-manager of Mackenzie Universal World Science & Technology Class, sponsored by Mackenzie Financial Corp., is reluctant to predict economic trends or when markets will turn.

“We don’t know if oil will go to US$200 a barrel, or if Israel will attack Iran,” says Rogoff, who works with co-manager Brian Ashford-Russell, founder and director of Polar Capital. “But based on what we do know, the market has mispriced the technology sector relative to the market. It has been massively devalued.”

@page_break@Some investors have likened the recent downturn to that which occurred in 2001. But, says Rogoff: “We can’t see the parallels between today and then. That’s why we feel sanguine about the relative prospects for the asset class.”

One reason for his optimism is that price/earnings multiples are much lower now. The sector, which used to command a 50%-60% premium over the general market, has seen that premium drop to around 20%. Moreover, Rogoff argues, the premium is really about 13% when cash on the balance sheet is taken into consideration. “This is the one of the lowest levels since 1992,” he says. “The premium has been meaningfully [devalued]. So, the risk looks limited vs the broader market.”

Second, Rogoff says, the sector’s earnings outlook is fairly good. According to data from Thomson IBES, earnings for the sector are expected to grow by 13% in 2008, and by 16.2% in 2009, vs global equity earnings’ growth of 5.4% and 16.4%, respectively.

Third, capital spending has been muted and the sector has not benefited fully from global growth. “Capital expenditure has been extraordinarily rational,” Rogoff says. “So, there should not be the same overhang for the sector as there was in previous downturns.”

From a strategic viewpoint, Rogoff favours large-cap companies, which account for 60% of the fund; there is about 30% in mid-caps and 10% in small-caps. “Ordinarily, we stay away from the bigger-cap companies because their growth profiles are generally not exciting enough,” he says. “But if you see good value relative to growth, it seems appropriate to move up the market-cap spectrum.” Rogoff and Ashford-Russell made that move at the start of the year to reflect a less positive view of global economies.

One of the larger positions in the 110-stock fund is Oracle Corp., a global leader in database management. “Unlike many technology companies, it doesn’t get negatively affected by the Internet,” says Rogoff, noting that the firm benefits from strong long-term maintenance contracts with major companies. “This is a business that throws off a lot of cash and is in a position to acquire a lot of smaller companies.”

Oracle acquired BEA Systems Inc. this past spring for US$8.5 billion. Oracle was recently trading at US$21 a share, or 13 times earnings. Rogoff’s 12-month target is US$25-US$27 a share.

Within the mid-cap space, Rogoff likes First Solar Inc. It produces thin-film solar-energy technology, which is considerably cheaper than conventional solar cells. “The solar industry is subsidy-reliant in countries such as Japan,” he says. “But First Solar does not require subsidies to operate at parity with the electricity grid.”

First Solar is on a growth kick; second-quarter sales were US$267 million, vs US$197 million in the first quarter. Rogoff acknowledges that the valuation is high, at around 40 times earnings. But he reckons that strong growth should push the stock to US$350 a share in a year, up from a recent US$267 a share.



Robert McWhirter, who oversees Northwest Specialty Innovations Fund for Northwest & Ethical Investments LP, is defensive and is holding about 50% of the fund’s assets in cash.

“We’re told if you can’t find something that meets your mandate, or you want to be cautious on the market, you can go to cash,” says McWhirter, president of Toronto-based Selective Asset Management Inc. “Because I deal with the most high-octane, high-beta stocks within the Northwest family, I can take advantage of the ability to move to cash more than other managers.”

Over the past year, cash has been as high as 57% of fund assets and as low as 6%. “We’ve been cautious since the fourth quarter of 2007,” he adds. “There was a significant market pullback in January 2008, and the market has bottomed since.”

As has occurred in the past, this could lead to the outperformance of the tech sector this autumn.

A manager who combines quantitative and qualitative analysis, McWhirter cites Ray Hanson, technical analyst with Toronto-based RBC Dominion Securities Inc., who says it could be mid-2010 before the storm clouds clear away from the overall market.

“When you look at the most recent earnings results of the S&P 500 composite index, you will see that second-quarter earnings expectations are off 16% year-over-year,” McWhirter says. “That is because of Grade A ugly numbers from U.S. banks.”

Technology stocks are pricey, trading at 17 times earnings, vs 14.3 times for the S&P 500. But tech companies are showing better earnings growth, at 15.1% for the current year, vs 2% for the broader index. “There is better near-term earnings growth in tech stocks,” he adds. “And the return on equity for tech companies is higher, at 25.5%, vs 17% for the S&P 500 index.”

An active trader, McWhirter is carefully picking over the market. “Overall, there are good opportunities, but only on a very selective basis,” he says. “We’re looking for the ‘tall, dark, handsome and rich’ stocks that meet our criteria.” McWhirter relies on a 12-factor model that screens stocks for earnings surprises and negative or positive revisions.

One of the top holdings in the 50-name fund is Allen-Vanguard Corp. The electronics firm makes jammers that are used in military vehicles to prevent the explosion of roadside bombs. Yet, there is some uncertainty about the firm’s future, as military allocations on the jammers have yet to be spent.

Acquired in March 2006, the stock was recently trading at $1.90 a share, or about three times 2009 earnings. That price is considerably lower than the peak of $11 a share in September 2007. Yet McWhirter is holding on: “We think things will improve because there is a sizable opportunity in other military applications.” He has no stated target for the shares.

McWhirter also likes Wavefront Energy & Environment Services Inc., which has invented a water-based technology that increases oil production of smaller wells in the early stages by 10%-25%. “It’s almost like a software company, as far as the business model is concerned,” he says. “It doesn’t sell its product but leases it. The recurring revenue is quite interesting.”

Acquired about six months ago at $1.40 a share, the stock recently traded at $1.90 a share. IE