Bear Funds Popular

Bear funds don’t always behave as one might expect.

Gary Lucido, 52 years old, an active investor for 25 years, learned that the hard way. In late December, Mr. Lucido bought the UltraShort FTSE/Xinhua China 25 ProShares ETF, which aims to give twice the inverse of the daily performance of FTSE/Xinhua index, which tracks 25 large Chinese stocks trading in Hong Kong. However, when he checked in early February, he found that while the index was down 15%, the ETF was up only 17%, instead of the 30% he expected.

“This was a big eye-opener to me,” Mr. Lucido said. ProShares gave him an explanation that also appears in its literature: The fund only aims to double the return on a daily basis, but due to the effect of compounding and volatility, over a period of time the return may be more or less than double.

Indeed, some of the biggest users of bear-market funds and ETFs are financial advisers and money pros who see them as an easy way to bet against the market, or sometimes just to hedge positions. Previously, they had to ’short’ individual stocks or ETFs, selling borrowed shares with the hope they could buy them back in the future at a lower price.

However, shorting can get complicated and has the potential for huge losses if markets rocket up. Closing a short position can potentially raise the price of a stock because short-sellers must buy shares to cash in on their bets — which may force even more short-sellers to close out their bets by buying, in a spiral called the short-squeeze. Short funds, on the other hand, can be easily bought and sold like regular mutual funds, and losses for fund investors are more contained because they don’t face a short-squeeze.

Not all bearish funds are gaining this year. For instance, one ETF that bets against the oil’s price, MacroShares Oil Down Tradeable Shares, is down around 40% over one year through this past Tuesday because of buoyant oil prices during the period.

Bear-market ETFs have other wrinkles. They aren’t as tax efficient as plain-vanilla stock ETFs for various reasons. For instance, they often invest cash obtained from the short positions into money-market or debt investments, which generate taxable income passed on to investors.

A handful of bear-market mutual funds have been around for more than a decade. Rydex Investments started the first such fund in 1994, now called the Rydex Inverse S&P Strategy fund. Direxion Funds introduced the second one in November 1997, followed a month later by ProFunds Group’s first bearish fund. Today, ProFunds is the leader, with $14 billion in bear-market funds and ETFs, while Rydex and Direxion hold $1.8 billion and $250 million in such products, respectively.

In the last two years, ProFunds rapidly built its lineup of such ETFs under the ProShares brand by starting 36 ETFs, including one this week. These include ETFs, which bet against technology companies, real-estate companies, and an emerging-market index.

Rydex also is looking to introduce more funds and ETFs that will bet against foreign stocks in specific countries as well as stock sectors, said David Reilly, director of portfolio strategies.

While the new funds increasingly are based on narrow indexes, there are some actively managed funds in which managers can make bearish bets as they see them. David Tice, manager of the $1.2 billion Prudent Bear fund, shorts stocks or market indexes he thinks will fall, while also buying some gold and mining stocks that tend to do well in market downturns.

Mr. Tice has managed to prevent the fund from falling too much, even in an up market. But there’s a cost. The fund has gained 5% so far this year, about half as much as the average bear-market fund. Still, it is in positive territory during the last three, five and 10 years.

Wall Street Journalmod=todays_us_nonsub_money_and_investing