Investors looking to protect themselves from stock market volatility by investing in a bear market mutual fund may want to reconsider. Bear market funds—which profit when stocks decline—have benefitted from two crashes in a decade. The second of those, from 2007 to 2009, erased $11 trillion in market value and left the Standard & Poor's 500-stock index below where it stood 11 years ago. Even so, bear market funds have been the worst performers among the 90 types of funds tracked by research firm Morningstar over the past 10 years, losing an average of 10 percent annually through Mar. 31. "Bear funds have had a really poor track record," says Nadia Papagiannis, an analyst at Morningstar. "One period of good performance isn't good enough to make up for several years of poor performance."
Bear funds have been a niche strategy since the first were launched in the mid-1980s. They attracted money after the recent market turmoil, with investors pouring a net $4.7 billion into them in 2009 and 2010. Assets in the 42 funds in the category peaked at $5.5 billion at the end of 2010 and today account for less than 0.1 percent of the $8.4 trillion in stock and bond assets, Morningstar data show.
The funds can bet against the stock market by short-selling individual stocks or by using derivatives to short indexes such as the S&P 500. Shorting involves selling borrowed securities with the expectation that their value will fall and they can be bought back cheaper at a later time.
Unprecedented efforts by the Federal Reserve to stimulate the economy have helped the S&P 500 double from the March 2009 low. "Prices do diverge from fundamentals if you have so much government intervention," says Douglas Noland, who runs the $1.3 billion Federated Prudent Bear Fund with Ryan Bend. "It's very difficult on us bears. It's frustrating." The fund rose 27 percent in 2008. It has fallen 44 percent since Mar. 9, 2009.
Only one bear fund has managed to beat the market over the past five years: the $1.6 billion Pimco Stocksplus TR Short Strategy Fund (PSTIX), run by Bill Gross, best known as manager of Pimco Total Return (PTTAX), the world's biggest bond fund. Gross's fund, started in 2003, had an average annual return of 3.1 percent for the five years ending Apr. 21, compared with 2.5 percent for the S&P 500. The fund uses derivatives to bet against the stock market and may use borrowed money and fixed-income securities to lift returns. If stocks are declining, investors gain from the short positions. If the stock and bond markets are rising, gains in the fixed-income portfolio may offset losses from the short positions. The Pimco fund returned 49 percent in 2008 when the S&P 500 fell 38.5 percent. The fund declined 14 percent in 2009 and 8.5 percent in 2010.
"The outperformance is due to the recent strong performance of bond funds in general and Pimco bond funds in particular," says Rick Lake, co-chairman of Lake Partners in Greenwich, Conn., which helps institutions choose money managers. Lake said investors need to be "judicious" about how much they put into bear market funds. The Pimco fund may be vulnerable to losses if the stock market continues to go up and an increase in interest rates pushes bond returns down. "If that happens, investors potentially have two ways to lose money," Lake says. "There is no all-weather strategy."
The bottom line: Two stock crashes in a decade haven't prevented bear market funds from losing an average of 10 percent a year over that span.