Funds that grin when the market bears it
NEW YORK — When it comes to mutual funds, a falling US stock market doesn't phase Dale Schmidt. Let 'em tumble, he says.
Mr. Schmidt likes all companies in a down market - be they small-cap firms, giant S&P 500 companies, big guns of the tech-heavy Nasdaq 100 Index, even selected Internet stocks.
Fact is, Schmidt will take their stocks either way: tumbling - or, admittedly better for most folks - rising. But rise or fall, he is ready for gain.
Schmidt, you see, is a portfolio manager with Potomac Funds, a mutual-fund group that specializes in enhanced-index funds, which seek to outperform a market index by at least 25 percent, and short funds (often called bear funds) designed to profit from a falling stock market.
Bear funds are currently the top guns of Wall Street, and about the only equity funds that made money during the first quarter of this year. Of a random group of 21 well-known bear funds selected by information firm Morningstar Inc., in Chicago, the average bear fund was up 27 percent through April 6, this year, compared with a loss of 15 percent for the average stock mutual fund.
Among better-known bear funds are Prudent Bear Fund, ProFunds Ultra Bear Fund, Rydex Ursa, and Potomac US-Short Fund.
Bear funds are not for casual investors, says Schmidt. "They are for someone who watches the market fairly carefully and is somewhat experienced," he says in a telephone interview from his office in Alexandria, Va. (Potomac Funds are headquartered in White Plains, N.Y., at 800-851-0511.)
Investors, he says, must have a basic understanding of what it means to "short" a stock. Essentially, the fund manager is selling a basket of stocks based on the perception that they are overvalued and their price is going to fall.
Sometimes folks fret about the concept of profiting from a falling stock market, Schmidt says. But his explanation doesn't really involve making money from other folks' miseries, such as a declining economy. Shorting is about "perception."
Any investor who profits from a rising stock market is assuming that his company will climb in value, Schmidt says, based on a perception that the firm has inner worth that will pay off in added sales and growth. The same is true with shorting, he says. A short-seller perceives that a company is currently overvalued, and will, in fact, fall in value to a more honest and accurate measurement of value.
The Potomac Funds have some 10 funds that let you invest "long" or invest "short." There is a money-market fund, plus enhanced index funds for the S&P 500, Nasdaq 100, Russell 2000 (a small-cap index), Dow Jones Industrial Average, and Dow Internet Index. The latter tracks both Internet-service and e-commerce firms. The "enhanced" index funds use various hedging strategies to try to eke out gains larger than the actual returns of the indexes.
On the flip side, there are short funds for four of the indexes just noted, excluding the Dow Jones Industrial Average. The Internet Short fund, one of those managed by Schmidt, is up a sizzling 143 percent for the one-year period through the first quarter of this year.
A quick look at the returns of Potomac's enhanced Internet fund and Short Internet fund vividly illustrate their differences. For the year 2000, for example, the enhanced fund was down about 77 percent, in a difficult year for Internet stocks. But the short-fund was up almost about 60 percent.
Analysts typically fault bear funds on two grounds:
1. They can be expensive to buy into.
2. They are too complicated for most investors.
"Bear funds are really not for average investors," says Russ Kinnel, who heads up equity analysis for Morningstar. "When stocks start to go back up, being in bear funds can wreak havoc with your portfolio," he says.
"Remember, the stock market is not predictable." Mr. Kinnel says, adding that key gains can come in just a few trading days in an entire year. If you happen to be in a bear fund, you will miss those gains entirely, and could be behind as much as 50 percent for the year. His recommendation: In a down market, average investors should stick with a solid bond fund, such as a short-term bond fund.
"You won't earn a lot, but you'll get 6 percent or 7 percent, which is decent, and will help ease your pain," Kinnel says.
Short-fund specialists like Schmidt don't deny that bear funds are specialized. But as investors become more familiar with them, they learn that they are not unaffordable, nor necessarily market Armageddon for small investors.
While it is true that entry fees are high ($25,000 for Rydex, for example, $15,000 for Pro-Funds, and $10,000 for Potomac), the funds typically offer diverse ways to get you in. Usually you can spread your money among several funds. And you can find lower entry minimums by going through a discount broker, such as Waterhouse Securities, Fidelity Investments, or Charles Schwab.
But their main selling point is also the most obvious: Short funds just happen to be making money this year. Tell that to the traditional funds!
(c) Copyright 2001. The Christian Science Monitor