Bear Funds Are Licking Their Chops

Seven funds that suffered through the Dow's streak see a juicy, falling market dead ahead

Apocalypse soon? With the stock market relentlessly going through thousand-point markers like so much kindling, some nervous investors are worrying about what would happen to their portfolios if the great '90s bull market should slip abruptly into reverse.

Not to worry, say mutual-fund industry bears. Although most of the nation's 6,270 mutual funds are more or less oriented to rising markets, a hardy though severely battered band of seven so-called bear-market funds are braced for Armageddon. They have deliberately structured themselves, through such techniques as short positions and put options, to hedge against major market declines or even make a profit.

HERE AT LAST? So far, of course, most of the bear funds have achieved lousy results over the past year or so (table), which isn't surprising considering the market has not gone their way. But some bear-fund managers insist their time has finally arrived. "The market is way overvalued...and if we have a bear market, we'll outperform almost every other fund," claims Paul Stephens, manager of the Robertson Stephens Contrarian fund. Charles Minter, co-manager of two Comstock bear funds, predicts at least a 30% drop in the market this year.

A handful of investors apparently agree. Most bear funds have seen steady redemptions for the last few years, but in the days following recent remarks by Fed Chairman Alan Greenspan about the overheated market, some funds reported spurts of new money. Michael Byrum, manager of the Rydex Ursa (Latin for "female bear") fund, says $60 million flowed into his fund in the first three days after Greenspan's Feb. 26 speech, boosting assets 25%. Some $7 million flowed into the Lindner Bulwark Fund on Mar. 3, bringing assets to $82 million. Still, flows into bear funds are raindrops compared to the vast sums still moving into traditional equity funds.

Of course, investors don't have to invest in bear funds in order to escape danger. One can merely switch into cash or money-market funds. The bear funds, though, try to do better than cash. A few of the funds have demonstrated that skill during brief downturns over the past few years. But the newer ones offer only the promise, or hope, of protection.

Investors who want to consort with the bears may want to look closely at how the bear managers plan to make money when the market finally plunges into the abyss they've been incorrectly predicting for years. Their strategies cover a wide range of global investments with varying degrees of risk. Some are similar to private hedge funds that rely heavily on short-selling, options, and futures.

The most successful bear fund is Stephens' Contrarian fund, the only one in the pack with a five-star rating from Morningstar Inc. The reason: good old-fashioned stock-picking. Stephens believes U.S. stocks are undergoing a speculative mania of historic proportions, and has positioned his fund for declining stock prices since he started it in 1993. He nearly beat the Standard & Poor's 500-stock index last year by investing in obscure mining and natural resources stocks in Third World countries. The fund is also heavily hedged. Stephens keeps about 25% of his fund in short sales, and he's been one of the few to make money at it. Short positions as of Dec. 31 are dominated by health-care and technology issues, including Avant, Sensormatic Electronics, and Stryker. Stephens also buys S&P 500 put options, which make money for the fund only if the market drops.

TOPS. Last year's best-performing bear fund, the Lindner Bulwark fund, followed a similar hedge-fund-like strategy. Bulwark's big gains came from long and short positions in natural resources stocks. Manager Eric Ryback says he is worried about rising interest rates this year and has positioned the fund for a 12- to 18-month bear market. He has put 13% of the fund into gold futures as an interest rate hedge, and upped his investment in S&P 500 and NASDAQ options. The rest of the fund is defensive as well. An additional 14% is in cash, 21% is in short sales, and the remainder is concentrated in natural resources stocks.

The other bear funds chalked up negative returns last year, compared with a 22.96% gain by the S&P. But not for lack of trying. One of the most aggressive bear funds going is the year-old Prudent Bear fund. Manager David Tice says he's positioned the fund for a long-term market decline that could take a decade for stocks to break even. He has sold short 57% of the fund's assets and owns puts on the S&P 400 midcap index and the Morgan Stanley High-Tech Index. The $15 million fund dropped 14% last year and is off 3.4% this year. But Tice says it will go up sharply if the market declines. When it dropped sharply in the summer of 1996--with the S&P 500 down 7.4% between May 24 and July 24--the Prudent Bear fund was up 14%, Tice says.

Few bear funds have had as bad a time as the Mathers fund. The fund has been bracing for a disaster since the mid-1980s, holding about 50% in cash and betting against the market by selling stock-index futures short. Since 1991 it has returned about 1.5% a year, making it one of the nation's worst-performing funds. "It's been an embarrassing and humiliating experience," says Mathers fund manager Henry G. Van der Eb Jr. Nevertheless, Van der Eb is sticking with his strategy in 1997. Through March 4, he's up 2%. His best hope for a turnaround is that his economic forecast proves correct: that the U.S. economy suffers a semi-deflationary recession that will trigger a decline in corporate profits followed by a bear market similar to the one now being experienced by Japan.

Charles L. Minter, manager of two bear funds at Comstock Partners Inc., is betting on a similarly gloomy future. His Comstock Strategy fund is 65% invested in short-term bonds, while his more aggressive Comstock Capital Value Fund is loaded with S&P index options and short positions in technology and capital-goods stocks. Minter draws parallels between today's market and the period before the 1929. "Even in the midst of a frenzied buying spree, even the most intelligent and astute of observers find seemingly rational reasons to justify the excesses," Minter says.

The Ursa fund takes the most direct approach possible to profiting from a bear market. It doesn't make any macroeconomic bets but simply positions itself for down markets at all times. It invests up to 5% of its assets in S&P put options. The rest of the fund is invested in government bonds, which provide income as a hedge if the market goes up. The goal is to inversely reflect the S&P, so the fund goes up 1% for every 1% the S&P declines. With bonds as a hedge, the fund tends to decline only 75% as much as the market gains.

Ursa, though, has a dismal record, having lost nearly a third of investors' money since the fund was launched in 1994. But its mechanical approach performs as advertised. When the S&P fell 2.6% in the first three days after Greenspan's comments, Ursa was up 3%. Ursa has a $25,000 minimum investment and is designed for professional investors who use it to time the market or hedge other investments, says manager Mike Byrum. "This is not a buy-and-hold, mom-and-pop fund."

But if the apocalypse really seems imminent, some moms, pops, and maybe even a couple of the kids might want to check it out.

Before it's here, it's on the Bloomberg Terminal.