Fears grow over shares bubble

THE hugely successful share offering from social networking website LinkedIn, with others such as Zynga (the games developer behind FarmVille and CityVille), Facebook and Twitter likely to follow suit, has left many wondering whether we are in the midst of another technology boom.

This is the view of a growing number of commentators and is coupled with a significant upturn in the performance of technology stocks. So is now the time for investors to dip their toes back into what in the past proved to be shark-infested water?

Many people will be understandably nervous about the prospect of investing in technology. While investors often have short memories, for many it will be extremely difficult to forget the dramatic boom and bust at the beginning of the millennium which left investors badly shaken and nursing considerable losses after they jumped in at the top of the market.

Back then there was a perception that every technology or technology-related company deserved to attract a premium, and dotcom companies, many with little real prospect of making a profit, were in hot demand.

This demand translated into stellar returns, with some stocks rising by several multiples and investment companies launching new funds to benefit from this investment hysteria and supposedly sure-fire way to make money.

We saw UK technology, European technology, biotechnology and packaged funds of technology funds, all of which attracted vast sums of money. The frenzy was so great that pensioners were coming out of cash and corporate bonds and reinvesting in technology funds so they didn't miss out on all the future gains. Then it all went horribly wrong.

The demise of technology funds and stock markets in general from 2000 to 2003 has been well documented. Over this period the feeling of hysteria was replaced with doom, gloom and despair; and many investors then sold out, crystallising substantial losses.

Since then we have seen the number of technology funds reduce from about 40 to just a handful, and these are all now much smaller. While investment companies were keen to launch funds during the boom, they have since been gradually closing and merging them into other funds.

However, a decade on and it seems that technology may be making a bit of a comeback. Technology is the best-performing investment sector over the past three years, returning an average of 63 per cent. This compares favourably with China, which has produced 58 per cent, UK shares at 26 per cent, UK corporate bonds at 20 per cent and property at just 5 per cent.These three-year figures hide a poor 2008 when technology fell by 25 per cent, although it subsequently rose by 48 per cent in 2009 and 23 per cent in 2010.

These performance figures demonstrate the potential volatility of investing in technology funds. To a large degree, this is also the risk of investing in stock markets generally, although today's technology funds are more likely to be filled with established and profitable companies such as Microsoft, Apple, Google, IBM, Samsung and Hewlett-Packard, than dotcom companies for which profitability is a longer-term aspiration.

The prospects for technology stocks also seem encouraging if the global economic recovery continues, particularly as many firms, having gone through cost-cutting exercises, have strong balance sheets and will be looking to upgrade their infrastructure and systems to improve competitiveness and help increase profitability.

However, there are undoubted risks, not least that any downturn in economic growth could see firms and individuals become more reluctant to spend on technology. Also, while there are large profitable technology companies, there are also those going to market that aren't yet making money.

For example, web-based music services site Pandora Media, group-buying site Groupon and Chinese social networking site Renren have all filed to go public, but none as yet is generating a profit.

This puts an added responsibility on investment fund managers to be discerning and make sure they separate the wheat from the chaff, something they have not always managed in the past.

So should you rush out and buy technology funds? Probably not, although an exposure makes sense as part of any well-balanced approach to asset management.

Otherwise, investors should be wary about buying specialist investments. If you invest in funds that specialise in a particular area, such as technology, financials or healthcare for example, then you are taking on more risk by concentrating more money on one sector. Your investment does well if that sector outperforms, and poorly if it underperforms.

The best approach is to invest in more diversified funds which will typically have exposure to a wide range of sectors, including technology, anyway. This will provide more than adequate coverage for the vast majority of investors, and so they shouldn't need to invest in specialist funds. Potential investors are also advised to ignore any hype around investment sectors and look at recent strong performance as a warning sign rather than an opportunity to buy.

• Patrick Connolly is a financial planner at advisers AWD Chase de Vere