Tuesday, February 01, 2011

The New Armageddon Fund

By an amazing coincidence, in the same week that I decided to resume my market timing analysis, a new type of bear market fund has emerged. AdvisorShares has created the first short ETF that actually sells stocks short: the Active Bear ETF (HDGE). I've been waiting for this ETF for more than three years, and it's almost the perfect bear fund.

As discussed in a previous post, my ideal Armageddon fund would (1) short a market index like the S&P 500 rather than a managed portfolio of selected stocks, (2) be easy to buy or sell in minutes without trading penalties, and (3) gain value in any bear market even if the derivatives market collapsed.

The following table shows how HDGE stacks up against other bear funds that I've used before:


HDGE SDS, SH, etc. BEARX GRZZX
Min. Invest None None $2,000 $10,000
Min. IRA None
None $1,000 $1,000
Derivatives
No Yes
Some
No
Expense 1.85% 0.95% 1.73% 2.86%
Trading penalty None None 1% (30 d) 2% (5 d)
Long stocks No No Yes No
Selection
Managed Indexed Managed Managed

Although dozens of inverse/short ETFs like SDS and SH have become popular investment tools, they may be extremely risky in a serious bear market due to their use of derivatives in place of actually selling stocks short. Indeed, during the worst part of the bear market in 2008 some of these ETFs temporarily stopped trading. My wish to avoid derivatives led me to search for less popular but safer alternatives to these funds.

The Federated Prudent Bear mutual fund (BEARX) was the first bear fund I found that actually held short positions in some stocks, but since BEARX also has long positions in some stocks and uses derivatives, I later dropped it in favor of the Leuthold Grizzly Short fund (GRZZX) which strictly sells stocks short. Neither of these was a completely satisfactory replacement for the derivative ETFs however, because they aren't indexed to the S&P, and because mutual funds take more than one day to complete a buy or sell order and come with hefty short-term trading penalties.

The Active Bear ETF meets my requirements for simple instant trading and the safety of real short positions in stocks. It would be nice if it were an index fund instead of a managed fund, but so far its price movements are close enough to the inverse of the S&P 500 index that its a pretty safe bet it will gain some value in bear markets - and that's the most important property of any bear fund in my market timing strategy.



3 comments:

John said...

Great info. I've used SH in the past but it is nice to have an alternative. I still think it is much to early to short this market but given the state of "irrational exuberance" that is taking place, it's only a matter of time in my opinion. I'm hoping for S&P at 1500 to make it super easy. We might get close yet this year.
John

Len Koop said...

Why the does the loss seem to double the S&P gain? Is this the constant trading cost? Thanks for the analysis.
http://www.google.com/finance?chdnp=1&chdd=1&chds=1&chdv=1&chvs=maximized&chdeh=0&chfdeh=0&chdet=1297890000000&chddm=1955&chls=IntervalBasedLine&cmpto=NYSE:HDGE&cmptdms=0&q=INDEXDJX:.DJI&ntsp=0

Jody Wilson said...

Len: That's the problem with it being a managed fund instead of an index fund. The only time I plan to buy this ETF is when I'm certain that the overall market is going down. The gain in HDGE may not be as great as the loss in the S&P 500 during the next bear market, but a small gain is better than no gain.