Some Funds Are Winning by Losing
By LAWRENCE C. STRAUSS | MORE ARTICLES BY AUTHOR
Mutual funds that place bets against the market have been doing better than their long-only rivals. And the trend should continue, so long as the bear keeps its grip on stocks. High-flying natural-resource companies such as Arch Coal and Peabody Energy are among the names that experts love to hate.
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MUTUAL FUNDS THAT short stocks have had a good run recently, at least compared with their long-only rivals, and, despite last week's gains, some of their managers see little hope of a sustained market revival.
Unlike hedge funds, few mutual funds do any shorting. Those that do often use differing strategies and take on different degrees of risk, so comparing them can be difficult. Funds in Morningstar's bear-market category are up more than 9% this year, versus a 12.7% decline for the S&P 500 and an 11.2% drop for the typical U.S. stock fund. (All data in this article are through last Thursday.) Funds in this category usually use various derivatives, such as futures, to hedge their bets against indexes. Most don't short individual stocks.
Table: Negative WagersSome other mutual funds can both go long and short. Morningstar's long-short group is down 3.9% this year.
The Calamos Market Neutral Income Fund (ticker: CVSIX), for example, pairs a company's convertible bonds with a short position in the stock. It also uses covered calls, which provide income -- although the downside is that the stock can be called away (bought) if it rises to a specified price. "Investors tend to use this fund as a way to stay in the market and be defensive," says John Calamos Sr., the fund's founder. Calamos Market Neutral is down about 3.6% this year, but still more than nine percentage points ahead of the S&P.
Whatever the strategy, several managers say this is an excellent market in which to bet against stocks.
"The spread between the best-performing stocks and the worst-performing stocks has gotten very wide," says Harin de Silva, president of Analytic Investors in Los Angeles. "It's a great environment for short selling if you can get the stock selection right." One fund the firm advises is the Old Mutual Analytic Defensive Equity (ANDEX), which does some shorting. (The fund has just been renamed Old Mutual Analytic.) De Silva wouldn't discuss any specific short positions. But as of June 30, the fund's short holdings included Mylan Laboratories (MYL), Leucadia National (LUK) and Louisiana-Pacific , among others, according to the fund's Website.
Stuart Goldenberg
"The spread between the best- and worst-performing stocks has gotten very wide," observes one investment pro.
The Aberdeen Long Short Equity Fund (MLSCX) has about 40% of its portfolio in short positions. "That's relatively high for us," says Chris Baggini, the co-portfolio manager. "We're very mindful that stocks are down a lot" but "the fundamentals aren't supporting stocks, even at current levels." He cites weak profit growth as a key problem. Baggini wouldn't discuss current shorts, but the fund's Website says that, as of June 30, it was betting against Bank of America (BAC), Sprint Nextel (S), J.C. Penney (JCP), American Express (AXP) and Starbucks (SBUX), among others. The Bank of America, Penney and Sprint positions were recently closed.
Barry James, co-manager of the James Market Neutral Fund (JAMNX), which tries to keep an equal number of longs and shorts, views last week's gains as a bear-market bounce. "The outlook for the economy is especially grim," he says. "The financial institutions just don't have money to lend. That puts a stop to the merry-go-round for the consumer and for commercial enterprises."
The fund is down 2.19% this year. Its short positions include Centex (CTX), a home builder whose stock has slipped nearly 50% in 2008 on earnings woes. Another short is Las Vegas Sands (LVS), a gaming and lodging operator big in Nevada and Macau. It's fallen over 50% this year, as U.S. consumers have slowed their spending. "This is a very tough economic environment for them," says the fund's co-manager, Brian Shepardson.
The Bottom Line:
While most mutual funds that can go short have produced losses this year, they've generally done much better than funds that can't and than the overall market.A third short is Cheniere Energy (LNG), which develops liquefied natural-gas terminals and pipelines. The company has a heavy debt load and has been losing money, as relatively little LNG is being shipped to the U.S. because buyers abroad are willing to pay more.
There aren't many hedge funds that are short-only. One is Seabreeze Partners Management, up 23.7% this year. Its portfolio chief, Doug Kass, now has his sights on the energy sector, which, of course, has had a huge run. His list of shorts includes Arch Coal (ACI), Peabody Energy (BTU) and Foundation Coal (FCL), all three of which have posted double-digit gains in 2008. These coal companies are vulnerable, in Kass' opinion, because they have big exposure to the weakening U.S. market and face growing competition from wind and solar power. They trade around 10 times next year's profit estimates, says Kass, "but that assumes unsustainable coal prices and profit margins."
More broadly, Kass maintains that the credit crunch is far from over, creating more shorting opportunities. "When credit becomes dear, it is a growth-limiting and P/E-lowering development," he says. "As long as this remains the case, the market holds little upside promise despite [last week's rally.]" If he's right, the short season could very well last a lot longer than the bulls believe it will.
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