Monday, April 06, 2009

Investing in Bear Funds

I was doing some research on mutual funds this weekend. I've been wanting to change some of my Roth IRA investments because they seemed to be underperforming even the sucky market averages in the last few months, and hadn't been doing well even before things tanked. Then, to complicate matters even more, E*Trade decided to shut down a couple of funds I was invested in, forcing me to have to sell and reinvest that money.

I ended up buying VBINX, (a blended stock/bond index fund with a low expense ratio) but while using all the fund screening tools on E*Trade, I was fascinated to see what the best performers have been over the past year:

RYCWX: "The investment seeks to provide investment results that will match 200% inverse of the performance of the Dow Jones Industrial Average. The fund invests at least 80% of assets in financial instruments with economic characteristics that should perform opposite to those of the underlying index. It is a nondiversified fund and enhanced index fund."

RYTPX: "The investment seeks investment results that correlate to 200% inverse of the S&P 500 index. The fund invests all assets in financial instruments with economic characteristics that should perform opposite to the securities of companies included in the underlying index. It is a nondiversified enhanced index fund."

URPIX: "The investment seeks daily investment result that corresponds to twice the inverse of the daily performance of the S&P 500 index. The fund takes positions in financial instruments that should have similar daily return characteristics as twice the inverse of the S&P 500 index. It employs leveraged investment techniques in seeking its investment objective. The fund invests assets which are not invested in equity securities or financial instruments in debt instruments or money market instruments. It is nondiversified."

All of these are up by more than 90% over the past year, which is not surprising for anything that's supposed to do the opposite of what the Dow does.

Over the past few months, I've often wished I was one of the people who could somehow make money from this disaster-- by short selling stocks, for instance. But that kind of transaction is a bit complicated and risky for someone like me. Mutual funds are much simpler, so it's tempting to buy one of these funds-- but again, for someone like me, I'm not sure it's a good idea. If I'd foreseen the market we've had over the last few months, owning a fund like these would have been a great hedge. Even over the past 5 years, they're all up right now, from 5-8%. But if the market continues to rally, they'll eventually be down. And remember, these are the top 3 performers-- I'm sure many other funds like this haven't done as well over the long term.

The key word in the previous paragraph is "foreseen." The other key thing is timing. No investor anywhere can see into the future, and even among the best economic minds in the country, last fall's stock market crash was not universally anticipated. So should a total amateur like me think she can predict this stuff? And even for people who saw a credit crunch coming, it had to take a lot of nerve, I think, to bet your money on the market tanking. To make the most of a fund like this, you'd have to know when to get in and when to get out-- remember that these funds track the inverse of the Dow times two, so if the market starts going up, you're down by twice as much. Conventional wisdom has always been that the average individual investor just shouldn't mess around with trying to time the market, but instead focus on long-term gains.

Of course, a lot of conventional wisdom seems to have gone out the window lately, so who knows. I'll keep this kind of investment in the back of my mind in case it ever seems like something worth trying. But I'm not sure I'll be able to recognize that moment when it comes. I wouldn't describe myself as a Pollyanna-ish optimist in general, but I think I and many Americans share a desire to see things positively, to see downturns as just small bumps in an otherwise easy road. On the whole, this probably isn't a bad attitude to have, as long as you aren't totally ignoring reality (although ignoring reality was exactly what a lot of people did over the last couple of years.) I think this sense of optimism makes it hard for people to do something that feels like investing in failure.

Here's an article from Kiplinger's about bear funds, for another perspective. What do you think? Would you invest in a bear market fund?


Anonymous said...

I was thinking the same thing! I just bought shares in an S&P short fund (SH). I like it because it's not too crazy -- no leverage.

Optioned Unarmed said...

Luckily for all of us, the world never changes, and existing power structures will continue to exist in perpetuity... Thus, the dollar will always be the world's reserve currency, the U.S. will always be #1, and the U.S. stock market will always go up over time.

Under such a certain and predictable future, who needs bear funds?

mOOm said...

Because market timing is hard (though not impossible) it makes more sense to invest in funds that are uncorrelated rather than buying a bear fund that you know will go down if the market goes up. For example, market neutral or long-short funds like TFSMX, or managed futures (there is some Rydex managed futures fund) but generally the latter funds aren't available to US retail investors unfortunately (but are to Australians).

simplesimon said...

I've been reading this blog for about a year now and I think this is the first time I've seen you mention what kind of funds you've held (there might be older posts where you've let the reader taken a peek).

Invest in index funds. You get what the market gives you (never under perform the benchmarks). Because of their low cost nature in both expense ratio and trading costs (internal turnover, taxes), index funds do better than the majority of its peers.

If you want to diversify away from stocks, go with a good quality bond fund like VBMFX (Vanguard Total Bond Market Index Fund). I would not invest in a bear fund.

Gord said...

I'm about to buy HOU It's a 2x OIL Bull etf out of Toronto. Inventories are way down, exploration has virtually stopped and the with the middle east situation along with Pakistan, and N Korea issues and oil not far off the $35 floor, it seems probable oil will come up (maybe dramatically)over the next 18 months. I don't see much risk.