Hi-tech offers big returns for the bold

Alison Eadie starts a series on specialist funds

Funds investing in global, growth industries are popular in the US, but have yet to catch on in the UK where asset allocation still tends to be country-based. Specialised US funds invest in telecommunications, software, biotechnology, consumer products, financial services, natural resources and more. A few funds are available in the UK that invest by sector rather than geography.

When Scottish Equitable launched its Technology Trust 11 years ago, there were 30 international technology unit trusts. Now there are four, plus a handful of offshore unit trusts and a couple of investment trusts.

Paul Kleiser, manager of Scottish Equitable Technology, believes the wild gyrations of technology stocks in the 1980s put many investors off. Growth in his fund over the years has come more from investment returns than new unitholders. The high US content of technology funds is also being viewed as negative by British investors. But as Mr Kleiser says, the UK is not an obvious place to invest. The US is the fountainhead of technology.

Technology stocks are still volatile, but the right ones do yield superior performance over time. Returns at the top-performing Prolific Technology unit trust have quadrupled in five years to the beginning of September turning pounds 1,000 into pounds 3,963 compared with a return of pounds 1,798 from the FTSE All-Share index, according to Micropal. Of course, not all funds have done as well.

The theory behind investing in technology is that it is a high-growth area, with high barriers to entry, still dominated by Western industries. Nick Train, fund manager at GT, points out that basic industries are struggling to add value against the tough competition and low labour costs of developing countries. "Our response as fund managers is to look for industries or companies with skills that keep them ahead and prevent erosion of their profitability."

GT's philosophy of investing in industries with an edge has proved popular in the US, where it runs several global funds.

Technology is seen as the Western world's answer to emerging markets. Tim Woolley, manager of Henderson Touche Remnant's Global Technology unit trust, says technology offers the same growth prospects and a similar risk reward ratio.

Although volatility is higher than in the UK market, it is less than in many emerging markets and should be ironed out over the long term. The issue of risk in technology funds is addressed by diversification among several stocks and stock markets and a spread of technologies.

Developments like the growth of the Internet and networking of computers are dominated by US companies, Mr Woolley says. HTR Global Technology in September had almost 70 per cent of assets in the US, 11 per cent in the UK and 8 per cent in Japan. TR Technology, however, Henderson's technology investment trust, had just 32 per cent in the US and 23 per cent in the UK split among companies such as Psion, Vodafone, Logica and Reuters.

Some specialist funds are widely spread. GT Telecommunications Fund's assets are allocated in Latin America, the Far East and eastern Europe as well as 30 per cent in the US.

Whatever the cushioning effect of diversification, stocks do occasionally bomb. In July the dip in the US market caused some smaller technology stocks to lose 40 per cent of their value. The worsening news of overcapacity among memory chip makers accentuated the market decline.

When stocks go wrong there is no escaping a big haircut, says Mr Kleiser. But he points out that the bounce back can be just as swift, as the US market has proved.

Contrary to some perceptions, technology funds often shun jam-tomorrow companies. John Ions, sales director at Prolific, says Prolific Technology looks for companies with positive cashflow, low debt, a good return on capital, proven products and real clients. It prefers computer software and telecommunications to biotechnology.

The top holdings in technology funds are usually big companies with an established dominance. Unquoted companies do not figure much. HTR Technology has 1 per cent invested. "We would not want to rule out unquoteds, but most technology companies are not blue sky. The industry leaders are those that deploy technology successfully and have blue-chip customers, says Mr Woolley.

So should investors be piling into technology funds? Mr Woolley believes so as the fundamentals are positive. Unless investors are bearish on the geo-political outlook, spending on technology must continue to rise.

Technology represents around 20 per cent of world stock market capitalisation. The industry is growing rapidly and globalising fast, in terms of demand and in the emergence of a new generation of technology companies.

Specialisation of technology funds is increasing, not just in the US. Swiss-owned Sarasin Investment Management last year launched TecSar, a global information technology fund marketed as a European unit trust and investing in computer-related companies, telecommunications and multimedia.

Sarasin believes IT offers investors dependable long-term growth, rarely found in the technology sector as a whole, that traditional industries can match. Guy Monson, Sarasin's investment director, says, "There is a whole market waiting to be tapped in what we believe will become a standard investment class in portfolios of the future."

As yet it has not happened in the UK. Technology funds are few in number and attract a small fraction of the money being directed towards emerging markets. Their charges are standard for specialist international funds.

The unit trusts charge an initial 5 per cent or 5.25 per cent and annual charges range from 0.75 per cent to 2 per cent. Although funds run by Prolific, HTR and Scottish Equitable have outperformed the UK stock market over the past five years, the worst-performing funds, which seriously damaged investors' wealth, are no more.

The answer as always is to choose an established fund manager with experience and a good track record.

In a low-inflation, slow-growth environment, investing in technology in theory offers investors the real prospect of outperformance.