Sunday, August 17, 2008

Bear Fund Comparison: SDS, BEARX and GRZZX

Thanks to some helpful pointers from readers following the earlier Armageddon Fund post, I've been able to compile a more complete set of data about the top bear-market alternatives to SDS, the ProShares Ultrashort S&P 500 ETF.

To review, SDS uses derivatives in order to make its price move in the opposite direction of the market, and at a magnified rate (2x). My concern is that a potential financial meltdown could undermine the derivatives market and hurt the returns of SDS (and every other leveraged and inverse ETF) during the darkest days of the bear market. The potential solution is to find a fund that uses actual short selling of stocks, and there are two funds that do this: BEARX, and GRZZX.

Unlike SDS, which is an exchange-traded fund (ETF), BEARX and GRZZX are mutual funds, so they are less flexible and more expensive. They require minimum initial investments, charge higher fees, and impose additional penalties for short-term buying and selling. In addition, whereas SDS is indexed to the S&P 500, these two mutual funds are operated by managers who only use a subset of U.S. stocks, meaning the managers might pick the wrong stocks and hurt the returns. For these reasons, I would only consider using the mutual funds for a one-time financial emergency; SDS is still the better choice for normal bear markets.

Min. Invest None $2,000 $10,000
Min. IRA None $1,000 $1,000
Major part
Expense 0.95% 1.73% 2.86%
Trading penalty None 1% (30 days) 2% (5 days)
Long stocks No Yes No
Indexed Managed Managed

Although the Prudent Bear Fund (BEARX) is cheaper than GRZZX, there are disadvantages that make it risker in a financial emergency. Long-time readers of this blog know that I've been keeping tabs on BEARX for over a year now. One of the things that attracted me to BEARX at the start was its ability to make money in a bull market, which is the result of having some long positions in selected stocks. In other words, BEARX is not a pure bear fund. The mix may work well for pre-correction defense in a bull market, but it just drags the fund down in a bear market. In addition, BEARX actually dabbles in the dreaded derivatives market, and since the whole point of this exercise is to find a derivative-free fund, that's a deal-breaker for BEARX.

As far as I can tell, the Leuthold Grizzly Short Fund (GRZZX) is the real deal. It only shorts stocks, and there appear to be no derivatives or long positions. Unfortunately GRZZX is the costliest of the funds, requiring the highest initial investment ($10,000 for non-retirement accounts) and charging the highest yearly fee (2.86%) and trading fee (2%). Even so, if I thought that there was going to be a crash and derivative meltdown on Tuesday, I would put everything into GRZZX on Monday. The extra costs might end up looking small compared to the slip that SDS would suffer.

The icing on the cake for GRZZX is obvious in the charts. Since the October 2007 peak, GRZZX (yellow) has actually outperformed SDS (blue) for buy-and-hold investors:

This should be impossible. SDS is leveraged so that it moves twice as fast as the S&P 500, yet GRZZX, which uses no leverage, has done slightly better during this bear market. Apparently the managers at Leuthold know how to select the best stocks for shorting! Meanwhile, BEARX (red) has been seriously lagging.

So GRZZX is now my choice for the Armageddon Fund. This doesn't necessarily mean that I'll use it - only that it's my choice if it looks like the derivatives market is about to collapse.

Update (February 1, 2011): There's an even better bear fund now, in the form of an ETF.

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