Investors eager to jump into the Internet arena, but wary of picking their own stocks, may soon have a new investment vehicle to meet their needs – and add risk to their portfolio. Two investment professionals with ties to the University of Rhode Island propose to start a mutual fund that invests in hot Internet companies such as Yahoo! and PSINet Inc. The Internet Index Fund, which as of press time was awaiting Securities and Exchange Commission approval, will track the 40 companies of the Dow Jones Internet Index. Each of the 40 companies derives the majority of its revenues from the Internet.
The fund will be passively managed, meaning that it will invest in the 40 companies of the index only. It contrasts with an actively managed fund, in which the money manager chooses stocks that he or she believes will beat the market.
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Integrity Global Asset Management, of Wakefield, is the company behind the new fund. Its president, Eugene Y.W. Lee, is taking a leave from his post as a URI professor to manage it. His partner, Jong Ho Hwang, is director of research for IGAM and has recently earned a master’s degree in business administration, with a focus on finance, from the university. He will be in charge of marketing the fund, which will be sold without a sales charge.
Part of the pitch is that the Internet is changing the economy, indeed our whole way of life, in fundamental ways. It therefore makes sense to bet on its future, Lee said.
“It has tremendous impact on all aspects of our daily lives, and has undergone record growth,” Lee said. “That’s why we think the Internet industry will outperform other industries for the foreseeable future.”
In making that prediction, Lee is betting that firms that have attracted swarms of investors despite their inability to show a profit will emerge from their investment stages as cash cows. For example, Lee said he believes Amazon.com – one of the index’s 40 firms – will be profitable in three or four years.
Indeed, the value of such companies comes from investors’ perception about their potential, Hwang said. They are attracted to companies that supply a product that was not available in the past because the technology was not developed, he said.
The fund, which Lee and Hwang predict will have $100 million in assets by next October, will invest in each company according to its market capitalization, the share price multiplied by the number of outstanding shares. Companies with the highest market capitalization, such as America Online Inc., will be invested in the most.
Of course, the fund is risky. Internet stocks jump and then dive, only to leap back up again. Because of the risk, Lee and Hwang recommend that investors dedicate no more than 5 to 10 percent of their portfolios to it. By virtue of its focus on Internet companies, it is an aggressive growth fund.
But if you’re going to invest in Internet firms, think long term, advises Chad White, a stockbroker and certified fund specialist with Barrett & Co., a Providence brokerage firm. The danger, he said, is that investors who buy stocks that have been appreciating steadily may get in just as the bubble is about to burst.
“If you’re looking short-term, it could be extremely dangerous,” White said. He added that investors who have a three to five year horizon would do well to consider markets that have under-performed in recent years, such as small caps – generally defined as companies that have $1 billion or less in market capitalization.
“My feeling is to buy when people don’t want the securities, not to buy after they’ve gone up significantly,” he said.
Lee and Hwang agree that investors must have long-term plans if they are to score in the Internet sector. Indeed, IGAM will hit investors with a 1.5 percent redemption fee if they sell their shares in fewer than 90 days. The fee should discourage people from pulling their money out with every gyration, Hwang said.
“It’s very difficult to manage the fund if we have inflows and outflows at every market turn,” he said.
That kind of steadfastness reflects Hwang and Lee’s belief in the efficient market hypothesis, the view that it is impossible to predict in which direction the market will head. That is why they believe that passively following the Dow Jones Internet Index is the best policy, especially given the volatility of Internet stocks. Indeed, Microsoft Corp. President Steve Ballmer sent technology stocks tumbling recently when he told journalists at a Society of American Business Editors and Writers conference that technology stocks, including those of his own company, were overvalued.
“But some people believe they can ‘time’ the market,” Hwang said. “They try it all the time.”
Not everyone agrees. Pran Tiku, president of Peak Financial Management Inc., a Wellesley, Mass. financial services firm, is one of them. While passively managed funds can play a small role in a diversified portfolio, Tiku said, it is generally better to have an expert select the securities. This is especially so with Internet stocks, he said, because of the uncertainty involved. While the firms in the Dow Jones Internet Index seem to be well established now, no one knows which companies will succeed and which will fail, he said. And the biggest winner five years from now may be an Initial Public Offering that has yet to be born, he said.
“Ultimately, there will be a whole lot of losers and very few winners,” Tiku said, adding that passive index funds do not, “give any credence to the fact that somebody should be doing a whole lot of research into what that stock is about before investing in it.
“If you want an easy way out, this is probably the way,” he added. “But I don’t think real wealth is made this way – you really have to work hard to pick the winners from the losers.”
But Lee and Hwang are confident they have a winner. They are now developing a marketing strategy and are looking to raise $1 million to $2 million in capital by selling an ownership stake in IGAM.
The fund has a $2,500 minimum investment for individual investors and a $1,500 for most retirement plans. Its expense ratio is 1.4 percent. Anyone interested in receiving a prospectus may call 1-800-234-0849. More information is available on the fund’s Web site, www.internetindexfund.net, and at the company Web site, www.igam.com.
In addition to the Internet Index Fund, Lee and Hwang hope to form new products in the future. Specifically, they hope to form an Offshore Internet Index that allows people in other countries to invest in the Dow Jones Internet Index without paying a withholding tax, which is the same as the capital gains tax. Many countries do not have a capital gains tax of their own, Lee said.
