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Mutual Funds
Berkshire fund is high tech's little secret
From his Silicon Valley viewpoint, portfolio manager Malcolm Fobes isn't concerned about the stormy sector. His fund is riding Microsoft, Cisco and AOL to smooth returns.
By Timothy Middleton
As technology stocks have been tossed about like driftwood on the sea in the past month, Berkshire Capital Growth & Value Fund (BFOCX) has somehow sailed calmly ahead, despite a heavy investment in the sector.
The share price is almost exactly where it was before the storm began in early April, leaving the fund ahead 29% this year, as of May 3. Meanwhile, assets in that same period have nearly doubled, to $7 million, as investors flock to a portfolio that Mutual Funds magazine proclaimed its Rookie Fund of the Year for 1998.
"The weakness in technology recently is due to the rotation into cyclical stocks -- there's nothing more to it than that," says Malcolm R. Fobes III, Berkshire's chairman and chief investment officer. Though his name is confusingly similar to that of a certain publisher in Manhattan, Fobes is nestled in the Silicon Valley of San Jose, Calif. The view from there, he insists, is serene. Tech stocks have run up and down every quarter for the past couple of years and, he says, what's been happening lately is "nothing new, and nothing to be concerned about."
Until his fund shot up 104% last year, Fobes and Berkshire were one of Silicon Valley's quiet little secrets. The firm, founded in 1993, invested privately in technology companies, attracting knowledgeable local investors such as former Sen. Alan Cranston. Fobes says he adopted the mutual fund format "very reluctantly," due to the "torrent of paperwork" it involves, and the portfolio is still not widely available; Berkshire says Jack White and Waterhouse Securities are among the few intermediaries who make it available.
But a hard fund is good to find, and Berkshire has been a rock. It puts about a quarter of assets in non-tech names such as Pfizer (PFE) and Berkshire Hathaway (BRK.B), but three-quarters of the 20 or so positions it takes are heavyweight techs such as Microsoft (MSFT) and Cisco Systems (CSCO). (Editor's note: Microsoft owns and publishes MSN MoneyCentral.)
"We're almost dead center in Silicon Valley here," says Fobes. "We are literally within walking distance of the Cisco Systems campus, and within three miles of our office are the headquarters of Intel (INTC), Yahoo! (YHOO) and Altera (ALTR). Our proximity gives us a real advantage in keeping an eye on what's happening in technology."
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Proximity, connections pay off
When tech cracked last fall, for example, Fobes had a close-up view. France's Alcatel (ALA), a huge telecommunications company, was among the first to fall, and quickly took other telecom infrastructure companies down in sympathy. Cisco's stock price was halved.
"I literally walked over there and talked to my contacts at Cisco and found there were no problems," he says. "Orders were robust; they were shipping routers on time. We were able to go in and buy Cisco at $45 a share; it closed the year at $95. So having the proximity and the connections, which not too many other fund managers have, gave us the advantage of being able to react very quickly."
Fobes says his investment style begins with sizing up the global economy, and looking for industries that are most likely to benefit from whichever trends are dominant at the time. Then he studies the leading companies in those industries, looking for such attributes as market dominance, franchise durability, sustainable revenue and earnings growth, strong pricing power and financials, improving returns on equity and the ability to generate significant free cash flow.
"Last, and most important, we look for experienced, motivated and creative management," he says. When everything clicks, he makes big bets on each position -- two-thirds of assets are concentrated in the top 10 names. Currently, the three biggest stakes are Microsoft, Cisco and America Online (AOL), followed by EMC Corp. (EMC), Intel, Yahoo!, Dell Computer (DELL), eBay (EBAY), Gateway (GTW) and Charles Schwab (SCH).
These are big-cap companies, Fobes says, because bigness is best in tech. "The larger companies get, the more powerful they become; they garner the disproportionate share of profits and market share," he says. Microsoft is the classic example. "The market doesn't want to have six or seven operating systems, so the market commands that there will always be one major operating system. It may tolerate one or two others, such as Unix or Apple OS, but the market commands that one will dominate."
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May invest outside of the sector
Berkshire reserves the right to invest as much as three-quarters of its assets outside of technology, "if it ever turns out that technology is not the place to be," Fobes says. Despite the sector's recent problems, however, the fund remains concentrated there.
"There is no doubt there has been some rotation into the cyclicals, but the real question remains, 'Will it stick?' " he says. His answer: no. "It's the nature of technology that there are periods of time when the market is euphoric over these stocks, and then it hates them. This is perfectly normal, and it's healthy, in fact."
Launched in October 1997, Berkshire is too new to be thoroughly studied by analysts such as Morningstar, which hasn't been able to calculate its expense ratio yet. It charges no sales load or 12b-1 fees, however, so the cost of ownership shouldn't be too high, and turnover to date has been almost nonexistent, meaning few taxable distributions.
The fund's risk profile is likewise imponderable. So far, it's been superb -- or lucky. In last year's third quarter, when the average tech fund sank 2.7%, this portfolio actually eked out a 0.5% advance. In the fourth quarter, when tech surged 42.9%, it shot up 57.9%.
But tech investors are less likely than most fund investors to fret about such things, and more prone to roll the dice. Berkshire, so far, has been coming up sevens.
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The next gorilla: One of the biggest bargains in tech right now, Fobes believes, is Yahoo!. Trading around $150, he values the stock at roughly $300. "We think Yahoo! has probably the world's best management in Mr. Tim Koogle," the chief executive, he says. Gross margins of 90% and net margins of 38% are comparable with Microsoft. "We're not even in the first inning of this technology revolution," Fobes enthuses. "This is where the next gorilla will be born, and the next gorilla, clearly, is Yahoo!."
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Overdue: "We love Cisco Systems," Fobes adds, forecasting annual growth of up to 40% for the foreseeable future. "It's clearly the dominant player in the networking equipment space, with terrific management, terrific growth and great margins." Not as undervalued as Yahoo!, he believes, the stock still has plenty of upside. "It's trading around $113 and we think it easily could hit $150," he says, especially if, as he expects, the company announces a stock split. "It's overdue," he says.
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