- The Washington Times - Tuesday, May 18, 2004

With so many Wall Street watchers making bleak predictions about where stocks are headed this year, a fund that’s designed to do well when the market falls might sound pretty appealing.

Bear market funds aim to do just that. But experts say this type of niche fund deserves only a low-profile role in your portfolio, if any at all. Most are aimed at large, institutional investors, who use them to hedge against losses in down markets. A handful are more accessible to individuals, but they are “not for the uninitiated,” said David Kathman, an analyst with fund-tracker Morningstar Inc.

“Bear market funds aren’t for most people. The vast majority of investors should stay away,” Mr. Kathman said.

Managers of bear market funds use a number of strategies, such as trading in futures and options. They also employ short-selling — in which they sell borrowed shares of stocks, hoping to capture a profit if the price falls. This means instead of looking for stable, winning stocks, they focus on companies they think will suffer the heaviest losses if the market declines.

Most are reverse-index funds, which means they try to generate the opposite returns of an index. For example, a fund like the Rydex Ursa seeks results that inversely correlate with the performance of the Standard & Poor’s 500 index. So if the S&P; falls 10 percent, Ursa would rise 10 percent. Conversely, when the market rallies, bear funds decline.

Some actively managed bear funds seek to mitigate this volatility. Prudent Bear, which has had some of the best long-term returns in its class according to Morningstar, attempts to minimize losses by making modest adjustments for market conditions. Fund manager David W. Tice, in the job since 1995, also invests heavily in gold, which is viewed as a hedge against economic instability.

Inflows into bear market funds show it’s getting harder to find optimists on Wall Street. Since the beginning of April, net flows into the inverse-index funds run by Rydex Investments are up $1.71 billion, including $1.44 billion into the Juno fund, reflecting a belief that interest rates are about to rise.

Juno inversely correlates to the price of the current 30-year Treasury bond. If interest rates go up, the price of the longest bond would likely fall, meaning Juno’s value would rise.

Not only do they perform miserably in good markets, bear funds tend to have high expenses, partly because the securities they trade — futures, options and derivatives — are more expensive than common stock. With the notable exception of Prudent Bear, most require hefty initial investments. For example, you need $25,000 to get into Rydex Ursa or Juno; Prudent Bear’s minimum investment is $2,000.

The most common reason institutional investors have for owning bear market funds is as a hedge, to mute losses within a very large portfolio when the market goes down. But small investors who buy bear funds because they are betting the market is about to decline are making a treacherous gamble.

“Timing the market, in general, is an extremely risky thing to do, and it’s not something I’d recommend anyone try,” said Mr. Kathman. “If you’re more worried about the downside potential, you might buy this. But you have to be willing to risk the possibility that you might lose some upside in the process.”

Financial planners say you are more likely to come out ahead with a simpler approach: crafting a broadly diversified portfolio and sticking with it. For the average investor, the best method is getting broad exposure to many different asset classes through passively managed index funds, which will cheaply diversify away most market risks, said Martin F. Kurtz, of the Planning Center in Moline, Ill.

“Using a bear market fund never has made a lot of sense to me,” Mr. Kurtz said. “Over the long run, if we look at the market in a general way, it goes up two-thirds of the time and down one-third of the time. So you’re buying a fund to protect against the one-third of the time when the market’s down? It’s just not logical.”

Volatility is inevitable whenever you invest, Mr. Kurtz said. The best way to manage it is to keep an appropriate portion of your portfolio in less-risky investments, such as bonds. It may not sound exciting, but that’s the point, Mr. Kurtz said.


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