Bear funds come up short in Q2

By Shawn Langlois, CBS.MarketWatch.com

One of six stories in our quarterly funds wrap-up. See also: Stock Funds Rally ; Bond Fund Winners ; Quarter's Top Fund .

SAN FRANCISCO (CBS.MW) -- In Churchill, Canada, near Hudson Bay, starving polar bears disoriented by a warming trend are turning on townspeople who once profited from their tourist appeal.

Some miles south, the same is happening amid Wall Street's changing climate. But they aren't polar bears succumbing to starvation; they're bear-fund managers -- the mutual-fund leaders who harvested fattening returns during the extended market collapse.

Of the 6,000-plus funds in the financial-research firm Lipper's universe of U.S. stock funds, the second quarter's bottom 20 is almost all short-selling funds. Collectively, bear funds are down 15 percent this quarter, vs. a 14 percent rise in the S&P 500.

"In the long run, it doesn't pay to bet against the American economy," said Christopher Haydel, senior financial advisor at American Express. "Participating in the economic miracle that is the United States is the most sound way to invest for the long term."

Consider the plight of ProFunds UltraBear (NAS:URPIX) , this quarter's worst performing U.S. stock fund. This former high-flyer -- which is leveraged to double the inverse performance of the S&P 500 -- has dropped almost the equivalent of 30 percent that it gained in the second quarter a year-ago.

The Rydex Dynamic Fund (NAS:RYCDX) , which is designed to double the opposite performance of the Nasdaq-100 Index, has also seen its performance whipsaw. It dropped 29.5 percent this quarter, versus a 47-percent increase a year earlier.

Still, the bear funds' retreat comes after a long run of success. The group is up an annualized average of 12 percent in the past three years vs. an 11 percent a year loss for the S&P 500, according to Morningstar, a fund-research firm that just started tracking the category June 2.

The top-performing fund in the period - David Tice's Prudent Bear (NAS:BEARX) - grew an annualized 24 percent.

During that three-year time frame, third-quarter 2001 shined brightest for the group, with an overall return of 31.7 percent when Sept. 11 sent the markets reeling. The top fund in that quarter was the ProFunds UltraShort OTC (NAS:USPSX) , which doubles down on the Nasdaq. The fund gained 117 percent.

The following is a list of the bottom 10 performers for the current quarter, only one of which, the Frontier Equity Fund , isn't considered a bear fund:

Bearing ahead

Chuck Tennes, director of portfolios at Rydex Funds, believes that positive investor sentiment, a negative for short-sellers, will continue into the third quarter. Still, the tech sector is rapidly becoming overheated.

"I'm a little nervous about the fact that whenever the market is feeling its oats, people start to jump right back in to tech stocks," Tennes said. "There seems to still be an excess of enthusiasm."

The Nasdaq Composite has soared nearly 18 percent over the quarter while the Dow Jones Industrial Average (DOW:DJIA) has added about 10 percent.

Even if the bull continues to snort in the near future, Tennes has no plans on tweaking the way he manages his fund, a fund that he says continues to attract investors even during the boom times.

"We don't change our approach," he explained. "Our purpose is to deliver very pure bear exposure to those who want it -- we don't undercut that decision. We're always 100 percent behind our strategy."

Who should invest?

With their volatile nature, relatively high expense ratios, and what some would describe as a party-pooping approach to equities, bear funds certainly aren't for everybody, but they do serve a purpose.

"Our inverse funds sell very well when the market is going up," Tennes said. "People tell us they've seen great gains, and figure maybe they'll take a little of that market risk off the table."

Russ Kinnel, director of fund analysis at Morningstar, on the other hand, is not a big fan: "Investors are better off staying away from these funds. The market tends to go up over the long haul and people are not very good at timing the market either."

Kinnel admitted that there might be an appropriate use for these funds but not as a long-term vehicle.

"One of the biggest rewards in the stock market comes from holding on or adding near the bottom," Kinnel said. "You have history against you but you also have a big opportunity cost in the fact that you might miss out on the next big move up."

Haydel has felt a palpable uptick in client interest, but said it usually comes in the form of questions not so much in the desire to allocate funds in that direction.

For instance, are these funds appropriate? How can they be incorporated into my overall portfolio? Are they useful considering my circumstance? During the market's Himalayan climb, these questions were virtually non-existent, but with steep losses come the itch to retool one's portfolio.

"Given the persistent weakness in the economy, its definitely leading more and more people to think in the direction of bear funds," Haydel said.

There's a time and place, according to Haydel who, like Kinnel, doesn't like these funds for anything more than a small-percentage hedge or as a short-term trade for those negative on the immediate state of the economy.

His rosy outlook on the economy has understandably been lost on many investors who've seen their portfolio shrivel from their highs. Recent resurgence aside, the wounds are still fresh. Hence the need, either perceived or actual, for some sort of strategy shift.

While a short-selling stance might make sense for some, he pointed out, there are intermediate measures that can be taken before placing a direct bet against the markets.

Precious metals, global bonds and natural resources, to name a few - Haydel tries to point unsettled clients in their direction before jumping into the more potent bear vehicles.

"These can provide you with plenty of stability and serenity during the storm," he said.