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"The strategy at work here is basically a view that
the e-commerce space is, one, hugely crowded, and two,
full of a bunch of flawed business models."
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Then we had to come up with some kind of weighting
scheme. If you think about cyberspace at the moment, it's
a work in progress. You really don't have identifiable
economic sectors -- you will, but I don't think we're
there yet. So what we adopted was this architecture --
infrastructure, application, intermediary, e-commerce.
Then we said, OK, within the Dow Jones Internet Index,
let's see how much of that index is represented by those
layers, and then how do we want to weight the portfolio.
Infrastructure is roughly a fifth of the Dow Jones
Internet Index, but it's half our portfolio. We're hugely
overweight there. By contrast, e-commerce represents over
a quarter of the Dow Jones Internet Index, but it's only
7% of ours.
The strategy at work here is basically a view that the
e-commerce space is, one, hugely crowded, and two, full
of a bunch of flawed business models. A lot of
shareholder equity is going to go to zero, because not
all these guys are going to make it. So we tried to
identify the companies that are successfully involved in
building this new global utility we call the Internet.
This portfolio has certainly had its bumps. If you look
at the performance year-to-date, and this was through
June 7, the portfolio on an absolute basis is down
6%, versus the Internet index, down 25%. So it's
doing better than the index, which is great. Nonetheless,
when you're down in an absolute sense, clients don't want
to know about relative return. You're just down.
TSC: That leads to a question. You've been bullish on
tech since 1993, you remained bullish through the winter
and spring when things got pretty rough. What was the
response from your clients? And, looking back, would you
have done it all the same if you had a chance to do it
over again?
Jeff Applegate: I would have done it the same. I long ago
demonstrated to myself that I have zero talent in terms
of sector rotating. I'm crappy at it. If you think about
tech, tech is a highly volatile sector. You've got short
product cycles, leadership changes. If you look at S&P
tech versus the S&P 500, it really started significantly
outperforming in something like the first quarter of
1993. But since that time you've had huge swings in
relative underperformance. It's been a little bit more
than an annual event. What we've decided is that as long
as we keep revisiting the fundamentals -- cap-for-labor,
what's going on with the Internet -- we're not going to
try to sector-rotate around stuff.
On our own metrics, trying to look at valuation for tech,
it was pretty clear to us by the middle of January that
tech had passed through fair value and was on its way to
getting overvalued. And then by early March it was
overvalued, no question. And I remember sitting around
with our group here, saying, We've seen this movie, we
know what the next frame is, but we're not going to do
anything. So we rode the whole thing down to the trough,
and that was hugely painful, and we had a huge swing in
relative performance in the portfolio. We were 10%
ahead of the market through March and then we were
10% behind the market by the middle of April.
TSC: At a point like that, when you're heading into March
and can see what the next frame is, do you take any kind
of defensive measure?
Jeff Applegate: I don't try to. Again, because that to me
is saying you think you know how to sector-rotate, and
you can time the point when you want to sell Cisco and
buy Duke (DUK:NYSE - news - boards). To me, that's too
short-term a call.
If you think about "the market," you spend about
a nanosecond at fair value on your way to a different
value. You're either undervalued or you're overvalued. So
when you get these huge swings in relative performance,
much as you overshot on the upside, you're going to
overshoot on the downside. Which is what I think
happened.
The way I think about performance for both of these
portfolios -- both of which are also asset-management
products for Lehman Brothers -- it's not forward month,
forward quarter, but forward 12 months. The portfolios on
a year-over-year basis look just fine. They're starting
to come back now, and I think forward 12 months it's
going to be OK and we'll be properly deployed for beating
the indices. But it's been a very difficult late winter,
early spring.
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"Every company on the planet wants to look as much
like Cisco and Dell as it possibly can."
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