The Inevitable: An Index Fund for the Internet Sector

By Rahul Seksaria, Assistant Editor

Investec Guinness Flight Global Asset Management launched the much awaited no-load Guinness Flight internet.com(TM) Index Fund today, July 30th, 1999. It will be the first index fund tracking the Internet sector. Investors seeking to overweight this industry sector in their portfolios will probably get the purest and most diversified exposure via an index fund. But the high expense ratio of the Guinness Flight fund takes a lot away from its luster.

"Going forward, we believe that the fund is a long-term integral addition to our family of funds. It is too early to say what expectations we have for the fund, but investors have shown a lot of excitement and interest," says James J. Atkinson Jr., head of the U.S. division of Investec Guinness Flight. "We recognize that the Internet is a volatile sector but we view it as an exceptional investment opportunity, and we believe that an index fund is a direct and convenient way for investors to access this opportunity."

The fund will seek to track internet.com Corporation's, Internet Stock Index, also known as ISDEX.. The ISDEX has received broad approval and acceptance as the bellwether Internet stock index. It's 50 stocks account for more than 90% of the market cap of all publicly traded Internet issues. The Guinness Flight index fund would therefore offer broad exposure to a very volatile sector of the market that has seen astronomical gains in the past few years. A great many people believe that Internet stocks are now highly overvalued and would be the first ones to be dumped in case of an investor panic. Investors should therefore be careful in deciding the relative weight of this fund in their portfolio. Many of the larger Internet-related stocks are already represented in other index funds. Even for those who are very optimistic about the prospects of these companies, the current valuations and risks associated with this sector might warrant a relatively small portfolio allocation.

Although there has been a recent pullback in Internet issues, investors should not use it as an excuse to overweight their portfolio with these stocks. It would be prudent to disregard short-term price fluctuations, and adopt a longer-term buy/hold strategy considering the volatility of the sector in general. For those who wish to have above-average exposure to the Internet sector, they must also be prepared to bear the additional risk (especially short-term volatility) that goes along with it.

The Guinness Flight internet.com^TM Index Fund has an expense cap of 1.35% but the company doesn't expect the expense ratio to exceed 1.25%. This is an expense ratio more in line with active funds. Apparently, Guinness Flight is exploiting the current Internet craze and the high returns produced by these stocks (so far) by charging an exorbitant fee for an index fund. It will be interesting to see if the high fee deters investors from pouring money into the fund. We will also keep our eyes open for an indexed Internet fund with much lower expenses, but we're not optimistic. This fund is clearly a "sector" fund, an area of the market Vanguard, DFA, and other credible fund companies have decided not to enter.

ISDEX is reviewed quarterly on a regular basis to maintain a well-diversified Internet portfolio. This suggests that turnover for Guinness Flight's fund will be higher than most index funds, causing a tax-inefficiency problem for taxable accounts. Coupled with the high expense ratio, the fund looks quite unattractive.

The fund requires a minimum initial investment of $2,500 for regular accounts and $1,000 for Tax-Qualified Retirement Accounts. Subsequent investments can be made with as little as $250.

Internet.com's ISDEX

ISDEX, a trademark of internet.com, made its debut in April 1996 along with The Internet Stock Report. It is a capitalization-weighted index comprising 50 stocks that represent the gamut of publicly traded Internet companies. These stocks represent more than 90% of the market cap of all Internet stocks. The index includes star performers such as Amazon, AOL, Yahoo and Ebay. It is a pure play Internet index as it only includes companies that fit the generally accepted definition of an "internet" company (one that receives more than half its revenues from or because of the Internet).

For a complete listing of stocks in the index including current prices, click here.

For more information about the index, and its futures and options, click here (link to the Kansas City Board of Trade).

07/30/99