In a topsy-turvy market, such funds tend to behave inconsistently
Of the 42 bear market funds tracked by Morningstar Inc., just a handful are actively managed and able to adjust to specific attributes or specific sectors of a bear market. The rest simply short — or short with leverage — a broad market index or benchmark.
October 16, 2011 6:01 am ET
From Investment News
Amid global economic turmoil, it is tempting to turn to so-called bear market mutual funds, which are supposed to go up when stock prices go down. The problem, however, is that such funds are one-sided, meaning that they only outperform when the market is steadily falling — not when it is seesawing.
Amid today's volatile markets, the performance of bear market funds tends to vary wildly, depending on what particular part of the market the fund is betting against.If that isn't reason enough to be wary, consider this: The vast majority of bear market funds are linked to a particular index. That is good when the index is falling, but not so great when it is rising.INDEX SHORTING
Of the 42 bear market funds tracked by Morningstar Inc., just a handful are actively managed and able to adjust to specific attributes or specific sectors of a bear market. The rest simply short — or short with leverage — a broad market index or benchmark.
Consider, for example, Direxion Monthly S&P 500 Bear 2X Inverse Fund (DXSSX), which aims to replicate before fees and expenses 200% of the inverse of the calendar month price performance of the S&P 500. The fund was up 14% during the first nine months this year, compared with the 10% loss posted by the S&P 500.
Last year, however, when the S&P 500 gained 15%, the Direxion fund was down 33.7%, and in 2009, when the S&P 500 gained 26.5%, the Direxion fund was down 59%.
“I don't use the one-sided bear market funds, because I'm not smart enough to know when to get in and when to get out,” said Thomas Meyer, chief executive of Meyer Capital Group, a $560 million advisory firm.
Like a growing list of financial advisers, he is a big fan of hedging the risk of a long-only portfolio of stocks and bonds, but he does it with long-short, market-neutral and merger arbitrage strategies that don't rely on permanent directional bets.
“Shorting is a very dangerous game,” Mr. Meyer said. “We use some alternative strategies to hedge volatility and limit the risks.”
Morningstar analyst David Kathman speculated that a lot of bear market fund investors are institutions that use the funds to hedge a specific long position.
ONLY FOR HEDGING
“That's really the only way these kinds of funds should be used — as a hedge,” he said. “But every time the market goes down, people will start to look at these funds because of the performance.”
The average return of the Morningstar bear market category through September was 5.2%, which is hardly a head-turner for a frustrated equity investor.
But that average includes five leveraged short funds with nine-month gains of between 31% and 52%.
Of course, on the opposite end of the spreadsheet, there are three funds with nine-month declines of between 28.9% and 34.4%.
In fact, 15 of the 42 funds in the category are negative this year, through September.
Negative returns in a bear market strategy when the market is down might not seem logical or even possible. But the reason is found in the details of each strategy.
The worst-performing funds in the category are, in one way or another, betting against rising interest rates at a time when interest rates have been holding at historic lows.
The oldest and largest fund in the category, which also happens to be one of the few that is actively managed, is the Federated Prudent Bear Fund (BEARX).
URSINE VETERAN
The $1.6 billion Prudent Bear fund, now managed by Ryan Bend, was launched by David Tice & Associates Inc. as the technology bubble was just gaining steam in 1995.
Of the 11 funds in the category that have been around at least 10 years, the Prudent Bear, with a 10-year annualized return of 1.5%, is the only one with a positive return for that period.
“Having a manager picking specific stocks to short is a much better strategy than just shorting the market, because you won't want to short the market all the time, and leverage introduces a whole new set of problems,” said Phil DeMuth, managing director at Conservative Wealth Management LLC, which has $100 million under advisement.
“If you're going to be a long-term investor in a bear market strategy, I could see a case for a small allocation to a dedicated short-bias fund that is actively managed,” he added. “Provided you have a manager you can believe in, a case could be made for some bear market exposure in any market cycle, but you're still betting that the manager can deliver alpha.”
Questions, observations, stock tips? E-mail Jeff Benjamin at jbenjamin@investmentnews.com
From Investment News
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