By JAN M. ROSEN
April 8, 2007
SourceTHE bears burst out of hibernation on Feb. 27, erasing the stock markets’ year-to-date gains and raising investors’ fears that the road ahead would be rough.
“I’m very pessimistic and very convinced that there will be very hard times — equal to the 1930s,” said David W. Tice, perhaps the most prominent bear fund manager. “This has been an incredibly long bull market,” he said, one fueled by a “credit-induced boom.”
He describes the current problems in the subprime mortgage market as the “first chink in the armor” and foresees a long bear market ahead.
Investment managers and analysts generally disagree on several counts with Mr. Tice — whose Dallas-based firm manages the Prudent Bear fund and the Prudent Global Income fund. They have far more faith that the American financial and economic systems will weather any squalls and they contend that in the long term, well-structured, diversified portfolios of stocks and bonds tailored to meet individual investment goals will do well.
These analysts are also wary of investors’ ability to “time the market” — to buy at the trough and sell at the peak or, in the case of bear market funds, to buy when the market is high and get out when it nears bottom.
“Don’t start moving things around when they look ugly in the short term,” said Tim Kochis, president of Kochis Fitz, a wealth management firm in San Francisco. A bear market can end as suddenly as it begins, leaving people who suddenly shift assets in a losing position.
“If anyone had timed the market successfully, we’d know,” he added. “The only famous investors are long-term strategic investors.”
David Kathman, a mutual fund analyst at Morningstar, said of bear market funds: “Basically most people don’t need these funds and shouldn’t be messing around with them. They are very volatile.” The market fell 3 percent at the end of February, he said, “so there is a temptation to panic, to try to time the market. If the market goes up, they get killed.”
Mr. Kathman called Mr. Tice “a longtime prophet of doom.” Nevertheless, he added, Mr. Tice was prescient in calling the 1999 bubble in technology stocks long before most analysts did. That was the same year when Mr. Tice cited problems of “accounting intrigue” at Tyco International, then a Wall Street favorite.
On Morningstar’s Web site, Mr. Kathman describes Prudent Bear as “the best of the bear-market funds.” It stands out because of its long-term performance, posting a 5.5 percent annualized total return over the five years through March, the only bear market fund tracked by Morningstar with positive five-year results. (The category’s average was a decline of 9.7 percent, annualized.) Prudent Bear showed a total return of 2.6 percent in the first quarter, well above the category average of 0.7 percent. It returned 9.1 percent in 2006, well below the 15.8 percent total return of the Standard & Poor’s 500-stock index, but in marked contrast to most bear market funds, which lost 8.9 percent, on average.
Prudent Bear, while focused on performing well in bear markets, managed to make money in good times because Mr. Tice and his associates manage it actively, selecting what to hold and what to short. Most bear market funds are managed strictly to perform in an inverse or double-inverse relationship to popular indexes like the Dow Jones industrial average or the S.& P. 500.
In the first quarter this year, the UltraBear inverse fund from ProFunds, which is intended to return double the inverse of the S.& P. 500 index, returned 0.9 percent. The Inverse Dynamic S.& P. 500-H, a fund from Rydex that is intended to provide twice the inverse of the daily performance of the S.& P. 500, also lagged Prudent Bear with a negative return of 1.2 percent. But over the five-year period, annualized, the UltraBear inverse fund had a loss of 12.7 percent, while the Rydex fund lost 10.5 percent.
All the funds are no-load, but ProFunds requires a minimum investment of $15,000 in self-directed accounts, well above Prudent Bear’s $2,000 and the Rydex fund’s $2,500.
Like managers of the bear market funds that correlate inversely to indexes, the Tice group shorts stock index futures — that is, it sells borrowed holdings, repaying the debt with holdings bought later, presumably when prices are lower. But unlike those inverse funds, Prudent Bear also shorts particular stocks that Mr. Tice sees as especially vulnerable, and 18 percent of the portfolio is long in stocks of precious-metals companies. The fund also has “lots of cash” and Treasury issues, Mr. Tice said. If the portfolio performs as he expects in the bear market he foresees, it could be an encore: in 2002, Prudent Bear led its category with a gain of 62.9 percent.
Mr. Tice forecasts a 50 percent to 60 percent decline in the market over the next two years. “What we have is gross credit excess” on both the personal and national levels, he said, and credit excesses fuel the speculative manias of classic boom-bust cycles. “Individuals are using their homes as an A.T.M. machine with home equity loans,” he added.
When the credit bubble bursts, both real estate and stock prices will fall, as will consumer spending, and jobs will be lost, he said.
The international situation is also precarious, in his view. “We are dependent on Japan, China, Russia, the Middle East to buy our debt,” he said. His second fund, Prudent Global Income, is essentially a bet against the dollar. It is invested in foreign and American Treasury debt and in gold and gold stocks. The fund returned 8.9 percent in the 12 months through March, 1.6 percentage points ahead of the world bond category, which it has outperformed over the past five years, as well, with an annualized total return of 9.41 percent. In the first quarter, its return of 1 percent was below the category average of 1.3 percent.
Despite the relatively strong long-term records of Mr. Tice’s funds, few market professionals are ready to embrace his dismal forecast.
“Look at history and look at logic,” Mr. Kochis said, pointing out that over time the market’s general trend has been up.
Michael Stolper, head of Stolper & Company, a San Diego investment management company, said he took a different path to defending portfolios against bear markets. He described the approach of the bear funds — selling short or buying puts — as tactical. “It’s like praying for a plague of locusts,” he said.
Mr. Stolper described his own approach as strategic, using fixed-income markets as a defense against bear markets. The fixed-income portion of a portfolio should be tailored to produce an individual’s income needs, he said, and the equity portion should be used “to build an endowment — for retirement, for children or charity.” The equity portion of capital is at risk, he said, “and is going to get ambushed from time to time,” adding that markets historically have risen about two-thirds of the time.
KURT BROUWER, president of Brouwer & Janachowski, an investment advisory firm in Tiburon, Calif., said the problem with market timing is that “you have to be right on timing, the direction and the duration — that is very difficult.” He added, “The market’s big moves up are often shortly after a downturn.”
“There are other ways to reduce volatility and yet get solid returns,” Mr. Brouwer said. Bond funds are one category that has a counterbalancing effect, he said. He also uses stock funds with a particular strategic focus to offset risk in equity funds that correlate more closely to the overall market.
The strategic funds he uses include the Merger fund, which seeks steady arbitrage profits from mergers and acquisitions; the Wintergreen fund, a world stock fund that Morningstar describes as “a hedge-fund-like mutual fund with a veteran manager,” David J. Winters; and the Legg Mason Opportunity Trust, which has done very well over the long term by relying on the idiosyncratic choices of the value manager Bill Miller.
“We’ve found it works well,” Mr. Brouwer said of his approach. “It reduces those white-knuckle times.”
Geoffrey H. Bobroff, a mutual fund industry consultant based in East Greenwich, R.I., said that a market correction is “a wake-up call to investors to rethink asset allocation.”
But, speaking as everyman, Mr. Bobroff cautioned: “I don’t know if this correction is a short-term bear market or long-term. If I put the hedge on now, I may have missed the opportunity.”
Copyright 2007 The New York Times Company