He who sells what isn't his'n hopes it won't soon be risen

Your Funds

Dollars & Sense

October 13, 2002|By CHARLES JAFFE

HIDDEN IN mutual fund results from the third quarter is an intriguing question.

To find it, look at the 62 stock funds - out of 8,400 - that were positive during the period.

Strip out the niche funds (such as those investing in gold) and funds that time the market (such as Forrester Value, a stock fund that is 100 percent in cash).

That leaves mostly funds that made money by "short selling" stocks.

The obvious question is: In this dreadful market, why aren't more funds selling short? Short selling is a tactic that creates profits when a stock declines in value. Deep into a downturn with no end in sight, you'd think that funds with the ability to bet on the negative would place a few chips on red.

Thousands of mainstream funds have the authority to sell stocks short.

Many sought that right from shareholders in the late 1990s as part of an industry trend of getting all funds within a family working under common, broad rules.

Fund firms that sought short-selling ability said they wouldn't actually use it. Of course, they were talking during a bull market.

"When funds said they wanted the right to sell short but wouldn't do it, no one took it too seriously," says Jeff Keil, vice president of the global fiduciary review group at Lipper Inc. in Denver. "As it turns out, most fund companies just seem uncomfortable with shorting and really have avoided it."

In a short sale, the investor (or fund manager) borrows stock from a brokerage and sells it, pocketing today's market price for the shares. If the stock's price falls, the investor buys the shares back on the open market and returns them - plus interest - to the brokerage, pocketing the difference in prices. If the price rises, the investor pays more to buy the stock back than they got for selling it, and pays borrowing costs, thereby creating a loss.

It's a high-risk strategy because the potential loss is unlimited.

Buy 100 shares at $10 each and the most you can lose - if the stock goes to zero - is your $1,000 investment. Say you short the stock at $10 per share; you lose your $1,000 if the stock doubles and you buy it back at $20. But you could lose a lot more if the stock keeps running against you before you repurchase the shares.

The risk is one reason why short sales typically are the domain of ultra-defensive bear-market funds or funds built for aggressive market-timing strategies. A recent study by Strategic Insight, a New York data-analysis firm, pegged the short assets in stock funds as totaling roughly $3 billion, less than one-tenth of 1 percent of all assets in equity funds.

While some mainstream fund managers periodically have shorted stocks - Mario Gabelli of the Gabelli funds and CGM's Kenneth Heebner come to mind - most have shied away from it.

The late 1990s story of manager Jim Crabbe and his Crabbe-Huson Special fund illustrates why. Crabbe-Huson Special (eventually sold to Liberty Funds Distributors, now part of FleetBoston Financial) adopted shorting provisions in the mid-1990s to guard against a downturn. But Crabbe got bearish early, going short on technology stocks just as they rocketed to new heights. From 1995 through 1999, the fund lost more than 20 percent, while the Standard & Poor's 500 index was up roughly 200 percent; years of gains in the fund were wiped out.

Managers also shy away from shorting because it has the potential to be viewed as straying from the fund's investment objective. If the strategy backfires, the manager can pay with his or her job.

Still, with all of the downward movement in the stock market, you would think that some struggling firm with the ability to short might have taken the plunge.

"There is probably an ego quotient at play, with management assuming they would be able to punch their way out of the bear market bag without having to resort to what would clearly be viewed by shareholders as an extremely risky step," says Jim Lowell, editor of the Fidelity Investor newsletter. "Shorting would have provided some relief, and why most managers wouldn't do at a time when it could have helped the fund it is a mystery."

But that enigma shouldn't send investors flooding into funds with short positions.

"A fund that starts chasing shorts now - or if an investor rushes into a short fund because of the last quarter - would be getting in very late in the game and could wind up making things much worse," says Russell Kinnel, director of fund analysis at Morningstar Inc. "There probably was an opportunity a year or two ago for more funds to take advantage of shorting ... but it looks like everyone missed it."

Charles A. Jaffe is mutual funds columnist at The Boston Globe. He can be reached by e-mail at jaffe@globe.com or at The Boston Globe, Box 2378, Boston, Mass. 02107-2378.

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