(PUB) Investing 2016

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11 Morningstar FundInvestor November 2016
Investing in technology should have been a sure-fire
winner over the past three years. Technology-
sector funds outperformed all other specialty- and
diversified domestic-equity funds, averaging an
11 .7% annualized return through Oct. 31. Over the
trailing one-year period, only specialty precious-
metal and utilities funds have done better. And yet,
some funds with outsized stakes in technology
have lagged their Morningstar Category peers consid-
erably. We took a look at funds with technology
stakes well above their category average that landed
in the bottom decile of the category over the three-
year period. Is the underperformance understandable
or a sign of a potential problem?
Touchstone Sands Capital Select Growth PTSGX was
the only Morningstar 500 fund in a growth category
with both a heavy tech stake and serious underperform-
ance. By and large, high-growth tech stocks have
been a winning bet over this time, and the more the
better. This fund averaged a 35.4% stake over the
past three years, compared with 23% for the large-cap
growth average. However, its annualized three-year
return of 2.5% over that time is well below the 7%
average. Its outsized technology stake was the biggest
positive contributor to returns, but that was offset
by a 7.5% average stake in energy, about twice that of
the category norm. (That is now down to a 2.2% posi-
tion in Schlumberger SLB, in the portfolio for more
than a decade.)
This recent record illustrates the risk of this concen-
trated, quirky growth strategy, but we recently
confirmed the fund’s Morningstar Analyst Rating of
Silver. Its strong process leads to long-term in-
vestments in businesses with strong balance sheets,
low debt levels, and strong cash positions, and
the fund is in the top decile of the category over the
10-year period, guided by lead manager Frank
Sands Jr. This remains a strong choice for investors
who can ride out periods of sharp losses and short-
term relative underperformance.
FPA Capital FPPTX averaged a 20. 8% tech stake
over the past three years, which should have given it a
big advantage over its typical mid-cap value peer,
which held only 10.8% here. However, it held even more
in energy, 24.6% versus 7.4% for the category norm.
Stock selection within energy confounded the problem,
and the managers’ tech picks were not stellar, either,
with Veeco Instruments VECO among the top 10
detractors. The fund actually lost an annualized 2.7%
over the past three years, while its average category
peer gained 5.2%. In this case, the 10-year num-
bers offer no consolation, with the fund landing in the
bottom decile there, too. This uncompromising
deep-value approach may still hold promise for patient
contrarians. However, lagging performance and
some turnover on the management team prompted a
rating downgrade to Bronze from Silver a year ago.
Berwyn BERWX was also in the red over the past three
years, with an annualized 1% loss, while its typical
small-blend peer gained 3.1% . That’s even though this
fund averaged a 23.7% stake in technology, com-
pared with only 14.6% for the category average. That
was a plus, but the fund’s other significant over-
weighting, basic materials at 11.8%, was crushing as
commodity prices dropped and its deep-value in-
vestments tanked. What’s more, it has a micro-cap tilt,
and micro-caps lagged stocks on the larger end of
the small-cap spectrum. There is no inherent flaw in
the process; the fund’s longer-term numbers are
stronger, and it has bounced to the top decile for the
year to date. The lesson here is to be aware of
the idiosyncrasies that will force the fund out of step
at times. K
Contact Laura Lallos at
These Funds Bought Tech,
but Underachieved
Red Flags | Laura Lallos
What is Red Flags?
Red Flags is designed to alert
you to funds’ hidden risks. Such
risks can take many forms,
including asset bloat, the
departure of a solid manager, or
a focus on an overhyped asset
class. Not every fund featured
in Red Flags is a sell, and in fact,
some are good long-term
holdings. But investors should
be prepared for a potentially
bumpier ride in the near future.