By David Randall
NEW YORK May 7 Long considered the best option for growth investors, technology funds have lost some of their edge. It may be time to reconsider how they get quickly expanding companies in their portfolios.
It's not just that many technology funds have large stakes in Apple Inc, whose shares have fallen nearly 23 percent over the last year as it lost share of the worldwide smartphone market to Samsung Electronics Co Ltd.
Instead, the industry is facing a larger problem: it's no longer filled with young companies whose best days are ahead. Now, nearly all major technology providers except for Google Inc pay a dividend, an admission of slowing growth that would have been unthinkable during the dot-com boom of the late 1990s.
"The last thing these tech companies want to be called is old and mature. I don't want to be called old and mature either. But at some point, that's what I am," said Mark Freeman, a co-manager of the $1.1 billion Westwood Income Opportunity Fund .
Add it up, and investors are left with a sector that is rapidly shedding its high-wired growth characteristics and settling into boring middle age.
While prospects of higher dividend payouts from tech companies could be good news for investors who want income, the shift could harm those who were counting on technology stocks to provide the growth to their portfolios. Surprisingly, investors can look to two traditional sectors for a boost: Consumer discrectionary and energy funds.
"Investors are probably thinking they're getting something from these tech funds that they're not," said Todd Rosenbluth, director of mutual fund research at S&P CapitalIQ.
There are several signs that the technology sector is aging.
Overall, 31 technology firms rated by Moody's will pay out dividends this year, compared with just 20 in 2007. All told, tech companies will send $44.4 billion in dividends to shareholders in 2013, a 35 percent increase from last year. And slowing earnings growth and large cash hoards earning little to no interest for shareholders will likely prompt companies to increase their payouts in the future as well, noted Richard Lane, a senior vice president at Moody's.
Apple posted its first quarterly decline in profits in more than a decade when it announced results on April 23. The slowdown in earnings growth looms large over the sector as a whole because many tech funds have a large stake in Apple.
With more than $145 billion in cash at hand and a price to earnings ratio well below the market average, many investors now consider the company more of a value stock, the term for a stock that trades lower than its fundamentals because investors expect its growth to wane.
"With increased competition, there's just no way that the company can keep up its growth rate like in the past," said Derek Gabrielsen, a financial planner at Strategic Wealth Partners, a Seven Hills, Ohio-based firm with $175 million in assets under management.
Freeman, the co-portfolio manager of the Westwood Income Opportunity Fund, said that Apple's share price may lag while its shareholder base makes a transition from growth investors to value investors. Apple may find itself in a similar position to Microsoft Corp, Freeman said, whose stock price has gained only 28 percent over the last 10 years since it initiated a dividend in early 2003. Apple shares, by comparison, were up nearly 5,000 percent over the same time.
GROWTH WITH CONSUMER AND ENERGY STOCKS
Consumer discretionary and energy stocks may be better options for investors looking to add growth to their portfolios.
Each sector has been turning in the most surprising growth rates compared with Wall Street's estimates. Through Friday, some 76 percent of companies in both sectors had topped analyst expectations over the most recent earnings season, according to Thomson Reuters data, more than any other sector.
Consumer discretionary stocks - the group of retailers, hotels and restaurants - pays an average yield of 1.6 percent, compared with an average of 1.8 percent among tech companies, according to S&P data. And even with lower dividend payments, consumer stocks have rewarded investors: the average consumer discretionary fund has returned an annualized 9.6 percent over the last five years, while the average tech fund returned 5.4 percent a year over the same time frame, according to Morningstar data.
Consumer discretionary funds are outperforming this year as well. The average consumer discretionary fund is up 16.9 percent for the year through Friday, compared with an 8.1 percent gain for technology stocks. Overall, the average stock fund has returned nearly 11 percent since the beginning of the year, according to Morningstar.
Investors who want to tap the sector could opt for a fund like the $783 million Vanguard Consumer Discretionary Index fund . The fund, which costs $0.14 annually per $100 invested, is up 17.2 percent for the year and yields 1.2 percent. Its largest holdings include Home Depot, Amazon.com Inc, and McDonald's Corp.
Energy companies will likely perform well as the global economy improves, noted Phil Orlando, chief equity strategist at Federated Investors. U.S. unemployment fell in April, while the rate of government job losses slowed, both of which should lead to increased consumption of energy by workers and businesses alike.
The Energy Select SPDR ETF is one cheap way to increase exposure to the sector. The $7.5 billion ETF, which costs $0.18 a year per $100 invested, is up 12 percent for the year. Its top holdings include Exxon Mobil, Chevron Corp and Schlumberger NV.