Bear-market funds sound great in downturn, but are too risky

Your Funds

May 07, 2000|By CHARLES JAFFE

My mail always has been full of letters asking about funds that have lost money in the last year or two. The questions typically boil down to "Should I sell?"

Lately, however, people are asking if they should buy funds with a history of losing money. That sounds crazy, but the funds drawing so much interest pursue bear-market strategies and try to cash in on the stock market's misfortunes.

While I typically can't say whether an investor should sell a recent laggard - because I don't have the investor's background necessary to make a decision on anything but a true, unmitigated dog of a fund - the bear-market fund decision is easy.

Don't do it. Bear-market funds sound great when markets turn ugly, but their intricate strategies and whipsaw performance potential make them inappropriate for all but the most savvy investors.

"People are used to making money, but they aren't making any in these market conditions so they think they can simply reverse what they have been doing to keep things rolling along," says Stephen L. McKee, editor of the No-Load Mutual Fund Selections & Timing Newsletter. "They won't necessarily get what they expect out of these funds."

To understand the strategy behind so-called "short funds," you need to know what "shorting the market" is all about. When you "sell short" a stock or an index basket of stocks, you are betting it will fall in value. (Buying a stock you expect to appreciate is "going long.") In a short sale, an investor borrows securities from a broker and sells them at the current price, planning to repurchase and return those shares to the broker at some point. If the stock falls as expected, the investor buys the shares back for less than he received selling those shares, and pockets the difference. If the market rises, the investor pays more to repurchase the shares and suffers a loss.

Some bear-market funds short the market all the time. Rydex Ursa and ProFunds Bear, for example, are designed to do the inverse of the Standard & Poor's 500. Rydex Arktos and ProFunds UltraShort OTC try to invert the Nasdaq Composite Index.

On paper, at least, if those indexes fall by 10 percent the funds gain 10 percent. (Expenses and other factors make it so that the funds don't quite deliver the exact opposite of the index.) Market-neutral funds mix short and long strategies, aiming for good returns in all market conditions.

In general, this unusual type of fund hasn't produced decent numbers in any market climate since they were introduced in 1997. Other bear-market funds use timing strategies, using cash, gold, or short sales to hedge the market. And there are plenty of ordinary funds in which the manager is allowed to sell short. They don't all do it - and investors may notice only when something goes wrong, such as when Crabbe Huson Special imploded by shorting tech stocks in 1998 - but they can.

What all bear-market funds tend to have in common is lousy long-term performance. Comstock Partners has an annualized average loss of 18.75 percent over the last five years. Prudent Bear's average loss the last three years is 19 percent. Rydex Arktos lost 45 percent last year, ProFunds Ultra-Short OTC was down 73 percent.

Historically, the market has been up roughly two of every three years, which means bear-market funds are fighting an uphill battle. Still, short funds have a place in a sophisticated investment strategy. Used as a hedge against a long position - in which you match your long bets against short ones - they make a portfolio conservative. If you are simply being opportunistic, they are a speculative market-timing tool.

Every now and again, such as April 14 when the markets suffered record point losses, bear-market funds look good. But it doesn't last long. Year-to-date, bear-market funds have been a mixed bag; some actually have lost more money than the average growth fund or the S&P 500.

"I don't know of a short fund on the market right now that has made money for anyone but the guys running the fund," says G. Edward Noonan of Triad Investment Advisory in Hingham, Mass. "The time to buy these funds was before the market pulled back. But it's foolish to buy a fund today that you wouldn't have considered six months ago when the market didn't bother you."

Charles A. Jaffe is mutual funds columnist at the Boston Globe. He can be reached by e-mail at or at the Boston Globe, Box 2378, Boston, Mass.

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