The Big Screen: The Best Short Stories
By Ian McDonald
Senior Writer
4/23/01 9:14 AM ET
Some funds have shown us that you can make money from sagging stocks, so let's check them out.
The Big Screen usually sifts the fund world in search of funds and portfolio managers who have an uncanny knack for picking stocks poised to rise in value. But over the past 12 months stocks and funds of nearly every flavor have headed south. When that happens, one of the few ways to make money in the stock market is to short stocks, also known as short-selling. Consequently, my mailbox has been filling with requests for a look at funds that short stocks. So let's check them out, but first let's talk about how shorting works.
To short a stock, you essentially borrow shares of a stock you think will tumble and sell them, hoping to buy them back at a cheaper price down the road. The opposite of being short a stock is to be long, where you buy shares of a company when you think they'll rise in value.
It might have been great to be long stocks in general, and tech stocks in particular, in 1999, but since then short-sellers have been in the sweet spot as an economic slowdown, sagging earnings and frothy stock valuations combined to rattle investors and send them to the exits.
There's a certain daredevil aura around shorting because it can be risky. When you are long a stock, you can lose your entire investment if its price goes to zero. But when you're short a stock, you can lose your entire investment and then some because a stock's price can theoretically rise forever.
Many investors use shorting on a limited basis to hedge against losses in stocks they own, but the strategy can also be used more aggressively. Our screen turned up funds that take either route. First, let's check out some funds that are solely dedicated to shorting. Most use derivatives to consistently post the exact opposite return of an index like the S&P 500 or the tech-heavy Nasdaq 100. Here is a gaggle of these types, ranked by their one-year returns.
The Year in Shorts
Fund 1-Year Return
Potomac Internet/Short 52.1
Rydex Arktos 35.1
Potomac OTC/Short 27.9
ProFunds UltraBear 27.5
Rydex Ursa 19.9
ProFunds Bear 17.8
Potomac U.S./Short 13.2
ProFunds UltraShort OTC 11.5
Rydex Venture 100 N/A
Rydex Tempest 500 N/A
Rydex Juno -0.7
Potomac Dow 30 Short -6.7
Source: Morningstar. Returns through April 19.
As you can see, it's been a good year to bet against stock prices rising -- funds like the Potomac Internet/Short fund are among this year's top performers. All of these funds are whipping the S&P 500's 10.5% loss over the past year, according to Morningstar.
Some simply went in the opposite direction of a sagging index like the Rydex Arktos fund or the Potomac OTC/Short fund, which both zig when the Nasdaq 100 zags. Others like the Rydex Venture 100 or the ProFunds UltraShort OTC fund use options to produce twice the opposite return of the Nasdaq 100.
These funds' returns might look great today because the major indices are underwater over the past 12 months. But it's important to keep in mind that historically stock prices have risen more often than not. That means that, more often than not, these funds are in the red.
Consider the feast-or-famine calendar-year returns posted by the Rydex Ursa fund, which heads in the opposite direction of the S&P 500. Yes, it looked great last year and so far this year, but its rock-bottom losses vs. its large-cap blend fund peers over the previous five years show that it's not really a core stock holding.
Rydex Ursa's Tale of Whoa!
The Ursa fund, which seeks the opposite returns of the S&P 500, pays off in a downturn, but is hardly an all-weather core holding.
Year Rydex Ursa Return Percentile Rank vs. Large-Cap Blend Peers (1=Best, 100=Worst)
YTD 5.7% 2%
2000 17.4 2
1999 -12.4 99
1998 -19 100
1997 -21 100
1996 -12.4 100
1995 -20.1 100
Source: Morningstar. Returns through April 19.
This is not to say that these short funds don't have a place in some investors' portfolios. When used in moderation, they can lighten losses in a down year. A portfolio that holds just the Ursa fund would look good recently, but not over the long term. On the other hand, a portfolio that only held the Vanguard 500 Index fund, which tracks the S&P 500 on the long side, would have fallen sharply over the past year.
But a portfolio with 90% of its money in the Vanguard fund and a 10% position in the Ursa fund would've had lower losses this year, but still posted competitive returns over the past five years. Over that period this portfolio would've also had 20% less volatility than the broader market, according to Morningstar.
Of course, there are some actively-managed funds that try to pick out both winners and losers. We sifted the U.S. stock fund bin for those funds with more than 5% of their money in short positions. Here they are, ranked by their short stake. We left out long/short and market neutral funds, a shrinking breed that aims for modestly positive returns each year.
Little Shorties
Fund Percentage of Assets in Short Positions 1-Year Return
Grizzly Short 78.6% N/A
CGM Focus 56.3 71.4%
Prudent Bear 71 13.7
Jundt Opportunity 24 -22.5
Merger 21.2 12.7
AIM Small Cap Opportunities* 21 -7
AIM Mid Cap Opportunities* 18.7 -18.6
AIM Large Cap Opportunities* 15.3 -5.3
Invesco Advantage 13.3 N/A
Jundt Twenty-Five 12.3 -24.3
Needham Growth 10.9 2.5
Quaker Aggressive Growth 9.3 -1.9
MetaMarkets.com OpenFund 5.6 -48.8
Avg. U.S. Stock Fund 0.03 -6.5
S&P 500 0 -10.5
Short positions as of most recent portfolio report. *Closed to new investors.
Source: Morningstar.
The funds on this list represent a broad range of strategies and their vastly different returns prove that shorting doesn't guarantee a profit in a down year.
The no-load Grizzly Short fund, co-managed by Charles Zender and Steven Leuthold, only launched last June but is up almost 7% so far this year. That gain beats 99% of its big-cap blend fund peers, according to Morningstar. Zender and Leuthold use quantitative screens to find mid- and large-cap stocks that they think are poised to tumble.
Ken Heebner uses a more gunslinger approach in running the no-load CGM Focus fund, but that's led to solid gains too. Heebner bought stocks in the energy sector last year as it surged and shorted 1999's tumbling favorites like Amazon.com (AMZN:Nasdaq - news) and Level 3 Communications (LVLT:Nasdaq - news), which are down 69.5% and 82.7%, respectively, over the past year. That's led to a 78.6% gain over the past year for the high-octane fund. Its 16.6% gain over the past three years beats 95% of its small-cap blend fund peers.
While these funds' recent gains make them shine, you also might consider funds that do less shorting -- a better idea for many investors. The trio of AIM funds, which are currently closed to new investors, limit shorts to 25% or less of assets.
"The short portfolio within the funds ranges from 10% to 25%," says Steve Brase, one of the three funds' managers. "Early last year we were on the low side of that range, but as the year progressed we went to the high end. [The short positions are] really designed to reduce the volatility of the fund. They're a shock absorber, helping us minimize losses in a down market and raise gains in an up market."
The funds are young, but they have looked steady. In 1999, an up market if there ever was one as all things tech charged north, the AIM Mid Cap Opportunities fund rang up a 125.6% gain, beating 92% of its mid-cap growth peers, according to Morningstar. But in 2000, when tech favorites fell, the fund posted a 10.1% gain that beat more than 80% of its peers. So far this year it's down 15.5%, but that's about in line with its competitors.
Another fund that opportunistically blends long and short positions and is open to new investors is the no-load Needham Growth fund. Manager Peter Trapp buys stocks of small- and mid-cap stocks when he thinks they're undervalued, while selectively shorting stocks he thinks are overvalued. It seems he has chosen his long and shorts wisely because the fund beats the S&P 500 and at least 85% of its peers over the past one-, three- and five-year periods, according to Morningstar.
These funds might seem foolproof because of their track records, but keep in mind that blending long and short positions isn't easy. If the stocks they buy fall in price and their shorts go up, you can lose a lot of money in a hurry.
They also tend to have higher expenses than more traditional funds that focus on long positions. The three AIM funds and the Needham Growth fund all have an annual expense ratio above 2%, according to Morningstar, compared to 1.44% for the average U.S. stock fund.
As these funds' varied results show you, shorting isn't easy, but it can pay off in a sagging market. If you were rattled by the past year's losses, a modest position in a short fund might make sense.
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Regards,
Barb |
