Bear funds starting to roar

Bear market mutual funds have come out of hibernation. For the 30 days through last Monday — the day major stock market indexes ended 10% down from their October peaks, signaling a market correction — the bear fund category had risen 11.27%, according to Morningstar Inc. of Chicago. It was the only equity fund category to post a positive return for the period. If the bear fund category can keep it up, it's only a matter of time before the category is able to achieve a positive year-to-date return. Year to date through Nov. 26, the average bear fund was down 0.76%, according to Morningstar. That's not surprising if you buy into what bear fund managers have been saying. Predictably, bear managers expect to keep the momentum going. One of the most popular bear funds — the $819 million Prudent Bear Fund from David W. Tice & Associates LLC of St. Thomas, U.S. Virgin Islands — has commentary posted on its website warning of "a death spiral, in which even sound, well-run institutions are engulfed." That such commentary would be posted on the fund's website is not shocking, said David Kathman, an analyst with Morningstar. David Tice, manager of the Prudent Bear Fund, "has been predicting gloom and doom for a long time," he said. Mr. Tice did not return calls for comment. Other bear fund managers, however, had similar pessimistic outlooks. The subprime mortgage mess is the primary reason, said Charlie Minter, co-manager of the $38 million Comstock Capital Value Fund and the $6 million Comstock Strategy Fund from Comstock Partners Inc. of Yardley, Pa., a unit of GAMCO Investors Inc. of Rye, N.Y. "The stock market has still not come to grips with the chances that the credit turmoil is likely to continue for some time and that the probabilities for a recession are high," according to commentary posted on Comstock's website. Over the next six quarters, about $1 trillion of mortgages will be reset to rates that will increase average monthly payments by about $300 a month, according to the commentary. About 450,000 households will be facing resets in each of the six quarters, meaning an even greater number of defaults are ahead, it said. At least some investors appear to agree. There has been increased investor interest in the $84 million Grizzly Short Fund from Leuthold Weeden Capital Management of Minneapolis, said Chuck Zender, the fund's co-manager. Of course, any time the market goes down, there is greater interest in the fund, he said. It's an interesting concept, said Richard Schroeder, executive vice president of Schroeder Braxton & Vogt Inc. of Amherst, N.Y. "I've thought about it," he said of investing in bear funds. "It's tempting, especially at times like these." But implementing a strategy that uses such funds is just too difficult, Mr. Schroeder said. It would be hard to argue that bear funds were suitable long-term holdings — because markets generally move up, he said. That means Mr. Schroeder would have to time the market to use such funds properly and he said he doesn't feel comfortable doing that. That's understandable, Mr. Zender said. "We're speaking to a small part of the marketplace," he said. The number of products that serve that market, however, are growing. In addition to a small number of such actively managed bear funds as the Grizzly Short Fund, the Comstock funds and the Prudent Bear Fund, there are numerous passively managed funds that short an index. The most recent trend has been the development of exchange traded funds that employ such a strategy. In just over a year, ProShare Advisors LLC of Bethesda, Md., has launched 58 ETFs — about half of which provide short or ultrashort exposure to an underlying index. Rydex Investments of Rockville, Md., launched its first six inverse ETFs last month, and plans to launch more. While such bear market products may be aimed at a niche audience, Mr. Kathman said he feared hot money from unsophisticated in-vestors could find its way into them. "It's easy for the man on the street to panic and get a bear market fund," he said. "People tend to get into these funds when they should be getting out." David Hoffman can be reached at dhoffman@crain.com.