Believe it or not, some presumably sane and sober investors are looking forward to opening their next mutual fund statement.
With the major stock market indexes teetering somewhere between devastating and disastrous, investors in turbocharged
bear market funds are actually raking in double- and even triple-digit returns.
Consider, for example, the $67.1 million Direxion S&P 500 Bear 2.5x Fund (DXSSX), which year-to-date through last Wednesday climbed more than 127%.
Other highfliers include Rydex's Inverse Nasdaq 100 2x Strategy Fund (RYVTX), with $188.6 million in assets and a 117.1% year-to-date return, and the $144.2 million ProFunds UltraBear (URPIX), which is up nearly 110%.
The funds, known as leveraged inverse funds, are designed to return up to two and a half percentage points for every percentage point that its index falls.
Of course, these high-octane bear funds would magnify investors' potential losses by the same measure.
This year's market downturn has fueled interest from investors, said Paul Brigandi, vice president of trading at Newton, Mass.-based Direxion Funds, which has $162.4 million in assets in leveraged index funds.
STEER CLEAR
To be sure, most financial advisers are telling clients to steer clear of the funds.
Returns can plummet as fast as they escalate. Plus, the funds are designed mainly for short-term investing and require an extensive understanding of how they work in order to be used effectively.
"Most people didn't capture all of these returns," Mr. Brigandi said. "They could have been in [the fund] one month or just three weeks at a time."
"Seventy to 80% of the time, the market goes up. So, if you are double-leveraged you'll have double the losses with double the exposure," said Ted Toal, senior partner of Triton Wealth Management of Annapolis, Md., which manages $90 million in assets.
"In an extraordinary market like this, the funds are pretty much doing what they should do," he said. "But they're not always that reliable."
Investors tend to buy into the funds at the wrong time, Mr. Toal said.
"I think there are better options as part of a portfolio," he added. "Commodities or managed futures are generally negatively correlated to the market."
Indeed, investing in leveraged inverse funds is a gamble, said Andrew Orr, president of OrrGroup Financial Planning of Orlando, Fla., which manages $25 million in assets.
"Risk management is the only thing I could see it being useful for," he said.
"We don't really do a lot of risk management because of the cost of doing that over time, like trading expenses," Mr. Orr said. "That can create a hurdle to the returns that are otherwise rightfully yours."
To be successful in using the funds, an investor has to be able to predict when the market will turn.
"It's basically gambling," said Morningstar fund analyst David Kathman. "For the average investor, it's basically just rolling the dice."
The funds could be used for risk management or a as a hedging instrument, Mr. Kathman said.
"And then only as a small part of your portfolio," he said. "It's more often a bad move, if you're doing it just expecting to get some short-term gains."
Nevertheless, investors have been flocking to the funds.
For example, investors poured $8.9 million into Direxion's S&P 500 Bear 2.5x Fund in August, compared with $4.2 million a year earlier, according to Morningstar Inc. of Chicago. Similarly, Rydex's Inverse S&P 500 2x Fund experienced net inflows of $5.2 million in August, compared with $919,000 a year earlier.
"I think a lot of investors are coming to the conclusion that the old days of buy-and-hold and set-it-and-forget-it might not work in this market," said Michael Sapir, chairman and chief executive of ProFunds of Bethesda, Md., one of only a few firms that offers leveraged funds and ETFs. "They are being more tactical in their approach. People are looking to take alternative approaches. We're seeing very, very high returns."
But the firms also promote investor and adviser education about the investments.
"We don't look at our funds as the only tools you should use in the investment toolbox," Mr. Sapir said. "For certain investors, they are tools that they can incorporate with other possible investments. We don't encourage unsophisticated individual investors to use these funds; they're for sophisticated investors who fully understand how they work. It shouldn't be their total investment program."
Other managers agree.
"It's definitely for active traders who are able to time the market," said Ryan Harder, senior portfolio manager of Rydex Investments of Rockville, Md., which launched the first leveraged fund in 1993 and now manages about $3 billion in leveraged inverse mutual funds.
"We always recommend that investors consult with a financial professional," Mr. Harder said.
Some advisers say leveraged index funds or ETFs can be used successfully.
The inverse ETFs are useful for hedging, as well as to capture market swings for total return, said Greg Zandlo, president of The Zandlo Financial Group Inc. of Minneapolis, which has $50 million in assets under advisement.
He reserves their use for a few younger clients. "But it's hands-off for anybody with 10 to 15 years to retirement or in retirement," Mr. Zandlo said. "I may use them for a short-term intra-day trade. I am very leery of keeping it open for any length of time. It's no doubt they are risky. But you have to stay on top of it. You'd better not be taking a vacation."
E-mail Sue Asci at [email protected].
