Chips are down on tech funds

For tech fund managers, the long-awaited fourth quarter is upon us - yet the traditional surge of tech stock prices expected around this time of the cycle has, at the time of writing, eluded us. Look around - most tech boards in Asia are still wallowing in their year's lows, with the Nasdaq in the US leading the falls.

In Taiwan, TSMC (Taiwan Semiconductor Manufacturing Corp) and UMC (United Microelectronics Corp), the darlings of tech funds, were in a state where they needed to have their share prices shored up earlier this month by the government's NT$500 billion ($16 billion) National Stabilization Fund. Has the semiconductor cycle short-circuited?
 
According to Ali Khalpey, manager of Merrill Lynch's Emerging Market Teletech Fund, investors in developed markets are nervous because of a spate of profit warnings which began coming out last month, starting with Intel. "Our [fund's] markets have a lower correlation with the US market than most, but when something like Intel has a profit warning, it's inevitable that other tech-related companies will have some huge sentiment factors attached to their share performances," Khalpey says. By region, more than 50% of Khalpey's Teletech Fund is weighted on Asia, with 30% on Latin America and around 17% on developing economies in Europe and the Middle East.

Although the market has been "abysmal", Khalpey says his Teletech fund has been able to outperform the benchmarks - MSCI Emerging Markets Free Information Technology and MSCI Emerging Markets Telecom - since its launch in September. "We still have a high level of cash in the fund and we're doing pretty well. But unfortunately the asset class on the whole is trending lower."

Comeback trail

Managers like Khalpey think certain tech stocks will make a comeback from October on because it has traditionally been the cyclical turning point where demand for semiconductors outstrips supply, as observed from the sector's track record in the past few years. The theory is that the demand for semiconductors is seasonal, but the supply is not. While demand in the first and second quarter tends to be low, supply in the fourth quarter usually falls short of demand, creating a shortage that helps boost stock prices, which then taper off throughout the first quarter of the following year. The market has not seen the trend re-emerging, yet. But managers are holding their breath for chipmakers' earnings reports, which they hope will kickstart the surge.  

Victor Lee, manager of JF Pacific Technology Trust, says investors have changed their focus on tech stocks from liquidity-driven to earnings-driven since the carnage in March, which saw countless dotcoms drop out of the fund-raising race because of concerns about cashflow. Now, he says, is a good time for investors to build up their tech fund portfolios for longer-term gains. By country, Japan accounts for 55% of Pacific Technology's portfolio, Taiwan 30%, and China, Korea, Australia and Singapore share the rest. By sector, the fund spans from consumer electronic manufacturers to internet software designers.

The performance of his tech fund in the past year has caused him "pain", Lee confesses. But he firmly believes the "pick-axe and shovel manufacturers will win no matter who strikes gold". The statistics that he lists are on his side: Japan exports 99% of the game consoles sold worldwide, Taiwan dominates 80% of the motherboard market, Korea makes 75% of the world's CDMA handsets, three Korean companies share 36% of the DRAM market, two Taiwanese chipmakers account for 35%, and growing, of the foundry pie, and China, even with a mobile phone penetration rate of as low as 8%, will have more than 100 million subscribers in two years' time. The list goes on.

Asia to remain a hub

There is no argument that the combined effects of low-cost production and advanced processing technology will keep Asia as the manufacturing hub for global electronic products. The concern is on how the US economic development will affect the Asian region. Much of Asia's tech sector growth, according to managers, will be in large part hinged on outsourcing. And, they say, it looks good every which way the US market goes.

India, for instance, received most of the software compliance work outsourced by developed countries in the period leading up to the Y2K countdown. As a result of their successful execution, the Indian city of Bangalore is now the hot favorite of western companies contracting out their web development work and remote services via the internet. The country's software export grew from $50 million a decade ago to $4 billion last year. Merrill Lynch's Khalpey expects that figure could multiply 10 times within five years.

Bad news on semis

On semiconductor manufacturing, it is even more unlikely Asia will lose out. A case in point is the production of wafer fabs (semiconductors), which are transiting from the current size of 8 inches to 12 inches. According to JF's Lee, 50 labs were built to produce fabs in 1996. The number has dwindled since. Next year there will only be 19 built. Lee states two reasons for the declining trend.

First, it has become prohibitively expensive for smaller players to build a new fab manufacturing plant, which can cost as much as $3.5 billion. Second, as the fab size is slowly migrating from eight inches to 12 inches, no one wants to invest in the old technology, while the new one is even more expensive. Major traditional players such as Motorola, on the other hand, prefer to focus on the design and marketing side of the business than having their capital tied up in fab production, which they have started to outsource. In the event of a slowdown of the US economy, managers say, the outsourcing trend will grow as companies tend to cut costs when business is in the doldrums.

The latest news from Taiwan this month is that the island's semiconductor industry is going to spend NT$14 trillion on upgrading manufacturing facilities in the next decade, plus building at least 15 new 12-inch wafer fab plants in a few years' time.