Bear Funds: A Bullish Stance On Bad Times

By Lisa Smith AAA

When oil and food prices rise, wages stay stagnant, housing prices decline and unemployment goes up, most investors don't expect much from their portfolios. Bad news and tough economic times generally herald tough times for most investors, as corporate profits plummet and stock prices decline. On the other hand, dismal economic news is music to the ears of bear fund managers and their investors. Read on to find out why.

What is a Bear Fund?
Bear funds love bad news, because bear funds are mutual funds that seek to generate positive returns when markets are in a decline. Generally speaking, an investment in a bear fund is a bet that the value of a particular index or portfolio of securities will decline.

There are bear funds that specialize in capitalizing on negative sentiment in the markets for stocks, bonds, currency, oil, gas, metal, real estate and more. If you can name a market, there's probably a bear fund looking to make a buck when that market takes a tumble. (Read Adapt To A Bear Market to learn more about how to weather a market downturn.)

How the Strategy Works
Bear funds can implement a number of strategies. Most specialize in short selling, buying put options and using leverage, which are not strategies for inexperienced traders. At the less sophisticated end of the range, some bear funds simply invest in companies that are positioned to generate positive results despite negative economic conditions. (To learn more about short-selling, read When To Short A Stock and Short Sales For Market Downturns. To get the inside scoop on put options, read Prices Plunging? Buy A Put! For insight into leverage, read Forex Leverage: A Double-Edged Sword, which provides an overview of how this tool magnifies both gains and losses.)

Actively managed and index strategies provide a choice of investing in an entire market or taking a more focused approach with security selection. Managers of actively managed bear market funds pick and choose their investments carefully in an effort to determine which securities are most likely to decline in value. Index funds seek to track a designated index in reverse. (Is your fund manager equipped to handle a market downturn? Read Has Your Fund Manager Been Through A Bear Market? to learn what to look for.)

With such a wide array of funds and strategies, one would not expect bear funds limit their forays to a single nation, and they don't. Bear funds are available for a variety of global markets. What all of these strategies have in common is that they are investments that have a negative correlation to the various markets they cover. (Read Going International to learn how investing oversees can protect your portfolio.)

Bears and Bulls
As the name implies, bear funds seek to make a profit from declining markets. They also seek, with varying degrees of success, to profit or at least break even when times are good. How have they fared? During bear markets, bear funds often live up to their billing, generating market-beating returns and capturing lots of media attention. At times they lead the pack, posting impressive returns in the faces of market malaise. (Read Going Against The Market to learn which investment vehicles can generate returns for the stout-hearted investor.)

When good times return and the bulls are running, bear funds often get pummeled, delivering such dismal performance that they attract substantial criticism from financial commentators. While they shine in the short-term, most bear funds have poor long-term track records. This is to be expected because, after all, markets tend to rise over time. For a closer look at bear fund performance, and the media attention that such funds garner, go online and search for "Prudent Bear Fund." It is one of the more famous of its breed, but by no means the only one available. Rydex offers several well-known bears, and a host of other bear funds prowl the markets.

Invest With Caution
If your considering the merits of a bear fund, be sure to limit your investment to a small portion of your overall portfolio. While investing the bulk of your assets in a single fund is generally not a good plan (with target-date funds being the exception to this rule), investing the bulk of your assets in a bear fund is a particularly bad idea. Bear funds tend to be volatile and often take hard hits when good times return. The success of the underlying strategy is largely based on market timing, so if you put all of your eggs in the bear fund basket, you could find yourself in trouble when the markets turn. By practicing diversification, you can enjoy a boost to your portfolio's returns when bear funds do well and limit the damage when good times return to the market.

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