August 9, 2011 / 4:16 PM / 8 years ago

As swift bear market bit, some funds were prepared

BOSTON (Reuters) - Some investors burned by the bear market of 2008 have gravitated to funds that use short-term tactics to avoid losses — and the strategy has paid off in recent months.

Traders work on the floor of the New York Stock Exchange August 8, 2011. REUTERS/Brendan McDermid

Such funds, like the $7.3 billion Eaton Vance Global Macro Absolute Return Fund or the $14.8 billion Permanent Portfolio, have recently outperformed the market and traditional lower-risk balanced funds.

These are not the leveraged short-selling funds that surge with each market decline. They are diversified funds with a bias: Their managers look for ways to preserve capital during market swoons.

The past month was a key test for the funds as they encountered one of the swiftest bears to bite investors in years. The average U.S. equity mutual fund lost 7.33 percent Monday and 19.31 percent over the past month, according to Lipper data. Even balanced funds known for conservative, diversified investments, lost 4.53 percent and 11.73 percent.

But the risk-reducing strategies of the ‘hedging’ funds appear to have worked better to preserve capital:

—The Eaton Vance fund, which spreads its bets for and against currencies, equities and bonds, lost just 0.56 percent on Monday and 1.19 percent over the past month.

—The Permanent Portfolio, hedging with precious metals and foreign currencies, dropped just 1.26 percent on Monday and 2.63 percent over the past month.

—Quant investing firm AQR’s $155 million Risk Parity Fund, one of the most complicated new offerings, uses a strategy of investing relatively more in bonds than a typical balanced fund. The fund lost 2.22 percent on Monday and 5.21 percent over the past month.

—The $164 million Forester Value Fund combines individual stock picking with hedges using puts on market indexes and the occasional short-positioned exchange-traded fund. The fund dropped just 1.82 percent on Monday and 6.09 percent over the past month.

The funds are not likely to do as well in a rebound as ones that are less risk averse. Stocks rebounded sharply Tuesday, but for a large population of cautious investors it was a fresh reminder to look for safe investing alternatives.


At Eaton Vance, Eric Stein and his co-managers have been anticipating problems in the United States and Europe for quite some time.

The fund’s short positions in European sovereign debt and bets on emerging market currencies have performed well in recent weeks as the crisis rolled on.

In the U.S., Eaton Vance is less concerned with the recent battle over extending the debt ceiling and Standard &Poor’s decision to downgrade. Instead, the firm is far more worried about the weakening economy that can’t seem to get back on its feet after the 2008 financial crisis.

Stein’s fund started shorting Greek debt back in 2005 but lately has cut back and shifted to more fruitful targets like the bonds of Spain, France and Belgium. Triple-A rated French debt looks particularly juicy to short, Stein said.

But this is not just a short-selling ambush. On the long side, the fund has bought the currencies of Malaysia, Indonesia and China. All three offer better yields than U.S. short-term accounts and feature economies with much better growth prospects, he said.


It’s impossible to create a perfect hedge, to be sure, and not all of the funds’ strategies paid off. Seeing a problem on the horizon is one challenge. Timing is another

At the $1.2 billion Leuthold Core Investment Fund, managers saw warning signs of a stock market drop building in July. Co-manager Andy Engel in Minneapolis, Minnesota, said the almost 200 economic and market indicators his firm tracks shifted from positive to neutral around July 15 and flashed “sell” by July 29.

It took a few days for managers to pare their 60 percent long position in stocks down to 45 percent. And they plan to go still lower, shooting for the minimum 30 percent permitted by the fund’s investment guidelines, Engel said.

“We think this is a new cyclical bear market,” Engel said. “From peak to trough, we’re expecting a 25 to 30 percent decline. That’s about 950 on the S&P 500.”

The fund lost 3.57 percent on Monday, slightly better than the average for balanced funds, and 12.22 percent over the past month, also better than most.

The fund was hurt by a small short position against U.S. Treasury 10-year bonds, which rallied sharply on Monday. The surprising strength of U.S. bonds after the Standard & Poor’s downgrade led to losses on the trade.

“The stunning thing was the debt was downgraded and people are flooding into T-bonds still,” he said. “People looking at the Treasury market as a safe haven are going to be sorely disappointed.”


Forester Value manager Tom Forester was able to position for the crash in time.

All year, Forester has been lightening up on financial and industrial stocks, cutting back positions in custody back State Street and manufacturer Honeywell, for example, while adding to defensive picks like Pfizer, Kraft Foods and Altria Group.

“A lot of these blue chip stocks have great balance sheets and their revenues are fairly stable,” Forester, based in Lake Forest, Illinois, said. All three declined in Monday’s crash but less than the overall market. “People are starting to appreciate risk again. You can’t eliminate risk but we try to manage it.”

Reporting by Aaron Pressman. Editing by Richard Satran

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