Saturday, March 25, 2006

Bear market funds

As their names suggest, bear market funds seek capital appreciation during down markets, mostly by utilizing futures, options and/or short selling. I realize placing bets on a declining market is not for everyone – in the personal finance blogsphere it might even be considered heresy. Yet history suggests that the market moves in cycles; bear markets follow bull markets as surely as night follows day.

Source: Profutures, click to enlarge

Personally, I maintain the belief that we are nearing the end of a cyclical bull within a secular bear market started in year 2000. The byline of this blog, “a middle way between active management and asset allocation”, is an acurate description of my investing approach. Roughly half of my portfolio is actively managed and the other half follows an asset allocation plan that I have been writing about. As I take a more defensive stance, my intention is not to achieve a net short position but to hedge against my exposure to the general stock market in the asset allocation accounts.

I have been dabbling with shorting individual home builder stocks, but it was with risk capital only, and based on a confirmed macroeconomic trend. The downside risks are unlimited in shorting individual stocks or ETFs, so it is preferable to use one of the bear market funds for general short-side exposure where one cannot lose more than the principle.

However antithetical this may be to your investing (or general) philosophy, I hope some readers are open-minded enough to file this post somewhere in the back of their mind, to be recalled at the appropriate time.

Without further ado, below is the list of bear market funds. Note all but one are geared towards producing inverse movements of a target index. A leverage of 1X means the fund aims to reproduce 100% of the inverse daily performance of the target each day; 2X means twice the inverse performance. In addition to the funds listed, ProFunds also offer various sector short funds. I own two of the funds mentioned, BEARX and URPIX. Some of these funds have related loaded shares with lower minimums, cater to nimble traders, or have order cut-off time other than 4pm. Readers are urged to do their own research before purchasing.

Select no-load bear market funds (data from Yahoo Finance 3-25-2006)
Fund Name Symbol Target Index Leverage Expense Ratio
Potomac Contrabond Inv PCBDX 10 yr Treasury 2X 1.75%
Potomac Small Cap/short POSSX Russell 2000 1X 1.95%
Potomac US/short PSPSX S&P 500 1X 3.32%
ProFunds Bear Inv BRPIX S&P 500 1X 1.51%
ProFunds Rising Rates 10 Inv RTPIX 10 yr Treasury 1X N/A
ProFunds Rising Rates Opp Inv RRPIX 30 yr Treasury 1-1.25X 1.42%
ProFunds Short OTC Inv SOPIX Nasdaq 100 1X 1.51%
ProFunds Short Small Cap Inv SHPIX Russell 2000 1X 1.51%
ProFunds Ultrabear Inv URPIX S&P 500 2X 1.43%
ProFunds Ultrashort Dow 30 Inv UWPIX Dow Industrials 2X 1.95%
ProFunds Ultrashort Mid Cap Inv UIPIX S&P Mid Cap 400 2X 1.82%
ProFunds Ultrashort OTC Inv USPIX Nasdaq 100 2X 1.41%
ProFunds Ultrashort Small Cap Inv UCPIX Russell 2000 2X 1.35%
Prudent Bear BEARX Actively managed, with gold stocks 1.85%
Rydex Arktos Inv RYAIX Nasdaq 100 1X 1.38%
Rydex Juno Inv RYJUX 30 yr Treasury 1X 1.32%
Rydex Inverse Dynamic Dow 30 H RYCWX Dow Industrials 1X 1.67%
Rydex Inverse Mid Cap H RYMHX S&P Mid Cap 400 1X 1.60%
Rydex Inverse Sm Cap H RYSHX Russell 2000 1X 1.63%
Rydex Tempest 500 H RYTPX S&P 500 2X 1.70%
Rydex Ursa Inv RYURX S&P 500 1X 1.38%
Rydex Venture 100 H RYVNX Nasdaq 100 2X 1.70%

The following chart compares BEARX with the 1X S&P inverse funds from Rydex and ProFunds. First of all, the gains during the bear market from 2000-2003 are self-evident. Secondly, the actively managed fund had greater volatility and return during the bear market, indicating a leverage greater than 1. After 2003, the volatility was about the same but BEARX had a higher return probably due to the gold component. Some basic mutual fund portfolios that use BEARX can be found in the archive of Robert Gordon.

So there it is. You may never have to purchase these funds, but it's always good to know what your options are.