Baron iOpportunity: Top tech

By Mark Salzinger, editor No-Load Fund Investor

Technology is an attractive sector in which to invest in the current environment. Though the sector is diverse in terms of investment characteristics, it generally offers superior growth opportunities and financial strength as compared with the overall market.

Over time, we have become more impressed with Baron iOpportunity (BIOPX), a multi-cap, no-load fund focused on technology stocks. The fund gained 61.8% in 2009, vs. 43.9% for the NASDAQ Composite.

Each of the following factors should help keep technology growth buoyant, even if the economy grows slower than expected.

One, partly thanks to the rollout of Windows 7 beginninglast October, the tech sector is entering a period of new-product introductions that should boost sales to large enterprises.Two, information-storage and security needs continue to grow.

Three, online commerce continues to increase. According to the U.S. Department of Commerce, e-commerce’s percentage of total retail sales has increased from less than 1% in 2000 to 3.4% by the third quarter of 2009.

So, not only has the rate of increase been fast, there is still a huge amount of market share to be gained. Four, consumers and businesses continue to demand all-in-one devices and services (note the hoopla surrounding Apple’s new iPad).

Five, dramatically lower borrowing costs for major corporations should allow them to increase their spending on big-ticket technology products and services in 2010. And six, above-average percentages of sales and profits in the tech sector originate in international markets, many of which are likely to grow much faster than the U.S.

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Meanwhile, major tech companies generally have relatively low levels of debt and high levels of cash. They are using some of the cash to purchase smaller players with key technologies. That’s one reason it makes sense to own funds whose technology holdings include not only the big names but also small and mid-cap stocks.

Michael Lippert began managing iOpportunity in March 2006. He joined Baron Capital in late 2001 after a decade practicing law (with a focus on high-technology litigation). The fund is akin to a hybrid, somewhere between a traditional Baron fund and a technology sector fund.

Ron Baron, the firm’s founder and most prominent manager, has long invested in the users of technology, but not its creators. His rationale was that technology changes so fast that products were too prone to quick obsolescence. This rendered tech stocks ill-suited for long-term investment.

So, instead of focusing mainly on traditional tech stocks in competitive (and cyclical) areas such as semiconductors, servers and the like, Lippert focuses on innovation within the sector as well as in areas of the overall economy that are undergoing technological improvements that can result in fast growth.

He manages the fund very broadly in terms of technology, with the modus operandi that the most innovative companies, in technology and elsewhere, will grow the fastest over a multiyear period, regardless of the performance of the economy.

Though iOpportunity includes some traditional tech stocks (including Microsoft, Google, Qualcomm and Apple), it favors lesser-known technology-related stocks that should benefit from various themes tied to innovation and growth.

Companies closely tied to advances in wireless-communications technology account for an important chunk of the fund, Lippert says. The big trend is that consumers and businesses want information, applications and entertainment anytime, anywhere, over the same device and from a single service.

Such products and services allow people to be untethered from their desks, with great ramifications for productivity. There’s also an incipient move toward so-called cloud computing, in which software and information are stored not on one’s own computer but over the Internet, available as needed.

Lippert also has positioned the fund to benefit from increases in advertising and purchasing over the Internet. The fund owns several e-commerce stocks, including Amazon.com and eBay, but also smaller retailers like Priceline and Drugstore.com.

The fund also has significant positions in healthcare technology, including stocks engaged in healthcare information technology, medical records, and electronic payments for medical services. It also includes companies providing technology for less-invasive surgical procedures and real-time diagnostics, so that healthcare can be delivered more efficiently.

It also holds stocks in sectors that might seem unusual ground for atech fund, including financial services (the fund includes at least two brokerage firms, for example), energy and for-profit education—examples of selections that benefit from technology, more so than fostering it.

What the fund’sholdings all have in common, Lippert says, is a focus on innovation through technology.Unlike many other techfund managers, Lippert doesn’t look for companies with catalysts for a pop in short-term performance. Rather, he wants to buy stock in companies that can achieve revenue growth of at least 10% to 20% a year, for many years.

And he wants to buy them at valuations that allow for a 50% gain in the stock over two years and a double in the stock over four. In terms of market capitalization, the fund’sassets are essentially divided in thirds among large, midsize and small stocks.

However, because smaller companies are generally riskier than larger ones, they have smaller average weightings and account for a larger number of the portfolio’sstocks. The fund’s median market capitalization was recently about $3 billion, which is on the smaller end of mid-cap.

The top 10 positions account for about 30% of the portfolio. Lippert says that the fund’slargest positions include his favorite stocks that have increased a lot in price and value as he has owned them.

He tends to trim holdings more and more as they rise in price toward and beyond a level where he no longer believes they can produce a double over the succeeding four years.He’s likely to sell a position outright if he has overestimated its fundamental strengths, including its competitive advantages and commitment to innovation. If a holding has maintained its fundamental strengths despite a disappointing quarter or two, Lippert may buy more of the stock if its price falls far enough.

Unlike Baron Capital’s other top performing funds, Baron iOpportunity is still fairly small, with only $180 million in assets recently. So, Lippert maintains excellent flexibility. We recommend the fund for aggressive investors.