Mutual Funds
Dec 13, 1999
Red Oaks Backdoor Technology Picks
Staff Writer: Judith Graham
Not quite a year-old, the Red Oak Technology Select Fund (NASDAQ:ROGSX - news) has emerged as one of the market's top technology funds.
Returning 115.6% year-to-date through December 8, Red Oak, which is Oak Associates' third mutual fund, has outperformed the S&P 500 Index by nearly 102 percentage points.
Not bad for a rookie, especially one with just 23 holdings in its portfolio.
So what's the secret behind its success?
Focus.
As co-manager Doug MacKay explains, Red Oak's $166 million portfolio is concentrated, even in the context of a sector fund. So you won't find many bellwether tech names in its holdings.
Rather, Red Oak is focused on Internet infrastructure-related tech plays.
Foregoing the opportunity to play dot-com stocks at the beginning of the year, MacKay and co-manager James Oelschlager, founder of Oak Associates, opted to play the net through the backdoor instead.
“The Internet is just like the PC was – as you have more bandwidth available, applications will just suck it up,” MacKay says. “We decided to focus on the companies that are selling the pickaxes and shovels to the miners. It's like that saying about the (California) Gold Rush: not a lot of people found gold, but those that [found fortune] were the ones who founded Levi (Strauss) and (sold) shovels.”
In line with that strategy, Red Oak plays the build-out of the Internet through infrastructure companies in the data storage, fiber optic, optical networking, and semiconductor sectors. MacKay says these sectors offer companies with strong cash flow and earnings, and have the highest potential for sustaining strong growth over a number of years.
And with such a low turnover rate – MacKay says turnover for the first 10 months of this year was about 16% -- Red Oak can't afford to keep slower-growth techs in its portfolio. “We're not looking for quick trades in and out,” MacKay says. “And we don't own old techs like IBM (NYSE:IBM - news) , Hewlett-Packard (NYSE:HWP - news) , and AT&T (NYSE:T - news) – companies with sub-10% earnings growth.”
On average, MacKay says the fund seeks companies with earnings growth of 20% or higher. What does he like?
Red Oak is heavily weighted in semiconductors, with companies such as Sun Microsystems (NASDAQ:SUNW - news) rounding out its top five holdings. MacKay lists TriQuint Semiconductor (NASDAQ:TQNT - news) as another favorite semiconductor play. With the explosion of higher-end networking devices, he sees strong growth opportunities for the sector.
“The chip guys are coming off the past three years of a kind of down trough and are now starting to get going again,” MacKay says.
In the fiber optics and optical networking space, MacKay likes JDS Uniphase (NASDAQ:JDSU - news) , which Red Oak has owned since the beginning of year, and newcomer Juniper Networks (NASDAQ:JNPR - news) .
While the fiber optics industry is still in its early stages, MacKay says the sector is gaining investor interest, especially in light of Cisco Systems' (NASDAQ:CSCO - news) recent purchase of optical networking equipment maker Cerent Corp. But the challenge is trying to pick those companies that will ultimately emerge on top.
“Right now the tide is lifting all boats in the fiber optics space, but we want to own the ones who will be the leaders after it subsides,” MacKay says.
Among Red Oak's data storage holdings, EMC Corp. (NYSE:EMC - news) and Network Appliance (NASDAQ:NTAP - news) , two of the fund's top five, are names MacKay believes have emerged as sector leaders. He also sees Brocade Communications (NASDAQ:BRCD - news) , which went public in May, as a rising storage sector star.
As MacKay explains, the fund's data storage holdings “all have leadership positions in strong, accelerating markets. In most cases, this leadership is evident because [the companies] have been through a product cycle in the past and management has shown the ability to survive the hiccups that occur.”
While the fund aims to hold stocks as long as possible, it's not restricted from exploring new territory.
Most recently, MacKay and Oelschlager found themselves focusing on larger-cap tech stocks that weren't up fivefold this year. Among Red Oak's larger-cap holdings, Dell (NASDAQ:DELL - news) , Cisco Systems (NASDAQ:CSCO - news) , also a top five holding, Microsoft (NASDAQ:MSFT - news) and Parametric Technologies (NASDAQ:PMTC - news) are stocks the managers believe are gaining further traction.
MacKay's ultimate favorites?
He reiterates top holdings JDS Uniphase (NASDAQ:JDSU - news) and Network Appliance (NASDAQ; NETA) as potential stalwarts.
“Fiber optics and storage are very large growth markets, and we think these two companies are similar to what Cisco looked like four or five years ago,” he says.
Bottom Line:
In a very short time, the Red Oak Fund has carved out a very profitable technology niche that focuses on fast growing companies with long-term staying power. The fund has a low turnover ratio because MacKay and Oelschlager keep their winners in the portfolio.
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