Fund Seeks Overlooked Tech Gems; Health-Care Tech Gives Manager Relief From High Internet Valuations

Fund Seeks Overlooked Tech Gems

Health-Care Tech Gives Manager Relief From High Internet Valuations

MATT JARZEMSKY

Oct. 28, 2013 6:48 p.m. ET

T. Rowe Price TROW +2.68% fund manager Henry Ellenbogen has made a career of discovering and investing in startup technology companies including Twitter Inc., and his $14.3 billion New Horizons fund has ridden Internet stocks to market-beating returns this year. But lately Mr. Ellenbogen is focusing on other areas—such as firms aiming to improve electronic records, care pricing and other aspects of the health-care industry, as well as innovators in financial payments—that he believes many market participants have overlooked.Surveying the Internet sector lately, “we’re just deploying less capital, because of valuations,” Mr. Ellenbogen said in an interview.

His shift underscores the increasing investor trepidation over rising technology-stock prices relative to revenue and profits heading into Twitter’s initial public offering, which is shaping up as the most closely scrutinized IPO since Facebook Inc. FB -3.31% went public in mid-2012.

Many corners of the tech sector have been on a tear so far this year. Technology firms in the S&P 600 index of small-cap companies are up 36%, outpacing gains in the broader market.

The Global X Social Media Index exchange-traded fund, which tracks companies such as Facebook and LinkedIn Corp. LNKD +0.96% , has advanced 52% in the year to date.

The New Horizons fund “significantly increased” holdings of Internet stocks between May 2012 and the end of last year, Mr. Ellenbogen said. Recent years’ purchases have paid off during a technology-stock boom this year that has some observers harking back to the late 1990s. Among the fund’s savvy purchases: Netflix Inc., NFLX -4.28% which is up 239% in 2013, and Groupon Inc., GRPN -4.49% up 93%.

The fund gained 41% in the year to date through Friday, according to FactSet, topping the 36% gain in its benchmark, the Russell 2000 Growth index. In the past three years, its returns put it in the top 1% of small-cap growth funds, according to Morningstar.

Internet stocks aren’t the only ones Mr. Ellenbogen is approaching with caution right now. Business software has been among the hottest corners of the IPO market in 2013, with six such firms popping more than 75% in their trading debuts in 2013, according to Dealogic. “The valuations are very, very high,” he said.

Dave Stepherson, who manages $750 million as chief investment officer at Hardesty Capital Management, agrees that social media companies and business-software makers that have gone public lately look richly valued. He looked into buying shares of cyber security firm FireEye Inc., FEYE -2.98% but declined after the stock doubled in its opening trade.

“Obviously we’ll look at something like Twitter but we’ll see a pretty lofty valuation, I imagine,” Mr. Stepherson said. “There’s going to be huge demand for it. We’ve already had clients asking for it.”

Mr. Ellenbogen isn’t in the business of placing bets on entire industries. He makes long-term investments in small companies with the potential to become large, as well as established, persistently expanding businesses with a unique operating mode or competitive advantage.

Facebook, which the New Horizons fund didn’t own as of Sept. 30, rallied 83% the two months after July 24, when it reported progress selling ads on mobile devices. Twitter, which the New Horizons fund bought in 2009, according to fund documents, expects its IPO to value the shares at $17 to $20 apiece, according to a regulatory filing. Mr. Ellenbogen declined to discuss his existing investment in Twitter and what he plans to do in the IPO.

Investors have been “really focused on which companies are on the right side of change, with what’s going on in mobile and tablets,” Mr. Ellenbogen said.

Conversely, companies using data science to improve the health-care sector—long an area of interest for Mr. Ellenbogen because of recent years’ improvements in information technology and the health-care industry’s size—are just starting to gain investor attention, he said.

Mr. Ellenbogen’s investments include medical records and billing software maker Athenahealth Inc., which has gained 88% this year, and privately held Castlight Health, a medical-service pricing and quality-information provider for employers and health plans.

Soaring health-care costs, consumers’ difficulty finding information about providers and the computerization of medical records have presented big opportunities for upstarts, Mr. Ellenbogen said.

“You’re basically seeing that opportunity matched with some examples of success,” he said.