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Bear Funds - Bear Mutual Funds and ETFs

As we discussed in our previous article on our hedged mutual fund portfolio when the market is moving against the bulls as quickly as it has been recently, its time to take another look at risk management strategies, and in this case specifically hedging strategies. There are a number of ways to hedge your mutual fund or ETF position, but our favorite is the use of bear funds or bear ETFs.

While our seasonal system has been sitting this correction out on the sideline (recall that because August and September are historically the worst months for the market, our seasonal system trades into cash every year in July and goes long again in October) that’s not the only risk management approach we take.

In our previous article on hedging with mutual funds, we took a look at the bear funds and ETFs that were available to hedge our long positions.

It’s this basic approach that is used in our hedge mutual fund portfolio. By holding a 20% position in a bear ETF (in this case the Proshares Ultrashort S&P fund, which is leveraged and attempts to track twice the percentage change of the S&P on a daily basis), we have managed to hold the drawdown on a backtested basis to about 6%, compared to the S&P 500 drawdown of about 50% from 2000 to 2002.

Of course the drawback to a static hedge ( that is a constant hedge whose percentage is not varied) is that over the long haul, since the market has historically trended higher over time, the overall return of the portfolio will be reduced.

The adventerous investor can of course vary the percentage of the portfolio that is in a bear fund or ETF based on some market timing model, but that’s a topic for another day.

Filed under Asset Allocation, Hedge Funds

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