A bear fund is a type of mutual fund utilized by investors to seek higher returns during market declines. These funds may be actively managed or structured to mirror an index. For instance, an index bear fund tracks the inverse of the underlying index.
Financial markets are ever-fluctuating. So, investors always look for strategies that can safeguard their investments and maximise returns. One such investment strategy that can help you sail smoothly and make robust profits during market downturns is investing in “bear funds.”
In this article, we will learn about the meaning of a bear fund, their examples, benefits, risks of investing, and how they work.
What is a bear fund?
A bear fund is a specialised mutual fund that has been designed to help you make money even when the prices are falling. These funds are mostly inversely related to the market’s performance. In simple words, the value of such a fund is expected to go up when the market goes down.
Bear funds usually implement a wide range of strategies, including diversification, active portfolio management, hedging, and short-selling of stocks and options. A bear fund requires a highly qualified and experienced fund manager who can navigate the market like a pro. Such fund managers provide you with the best possible returns when the overall market is down by 20% or more (the condition required to call a market a bear market).
You should invest in a bear fund if you want to hedge against or capitalise on market declines.
Example of bear fund
Let us try to understand what a bear fund is with the help of an example.
Imagine there is a mutual fund scheme that replicates the daily performance of a benchmark index (say, Nifty 50) inversely. What does this mean? If the Nifty 50 index decreases by 5% in a day, the concerned mutual fund will increase by 5%. How does the fund achieve this? The concerned mutual fund scheme invests in a wide range of stocks, mutual funds, repurchase agreements, RBI notes, and more to provide you with the desired inverse result of the benchmark index.
How do bear funds work?
Bear funds work by short selling, diversifying their portfolio, and implementing various other investing strategies. According to the short-selling strategy, the fund manager borrows shares of a stock or other asset that they believe will decrease in value. If the estimation comes true and the stock price indeed falls, the fund manager will buy back the shares at a lower price. They then return the shares to the lender.
This means the fund manager first borrowed some shares from another person who had them, then anticipating a fall in that stock’s price, sold the shares at the then existing price, and ultimately bought them back at a lower price when the stock price dropped as per their anticipation. This helps the fund manager make a profit from this price differential. Bear funds use derivative financial products such as futures and options. These strategies are used successfully by fund managers to provide you with positive returns. However, there is a high chance that the fund manager’s expectations do not match the reality. In such cases, the investors will make losses.
Hence, bear funds are high-risk investments, and they are mainly used by experienced investors.
Performance of bear funds
Historical performance shows that bear funds have a poor performance record. Let us try to understand the reason behind this trend.
Usually, bear funds are considered risky investments because they resort to short-selling strategies, which are inherently risky. They are highly risky because of three main reasons:
- Short-lived: Bear markets are usually short-lived when you consider the long run. So, having a strategy to make a profit based completely on downward price movement can be beneficial only for a shorter period. Historical trends show that bull markets tend to last for around 965 days (2.6 years) and bear markets only for 289 days (or just over 9 months). Market analysis also shows that a bear market tends to take place after every 3.5 years.
- Tougher to predict: Short-selling strategies are tougher to manage because predicting a downward price movement requires advanced knowledge of fundamental and technical analyses. It is not a cup of tea for every investor. Only a few fund managers can use short selling to hedge your risk and make money in the bleeding market conditions.
- Timing the market is more difficult: Timing the market is easier said than done. Excellent understanding and practical experience in technical analysis help in timing the market. But when it comes to actually placing your orders, it becomes tricky even in upbeat market conditions. When the market is bleeding, it becomes even more challenging.
If you are a long-term investor, bear funds are not the best option for you. Bear funds are ideal only if you want to make money from the comparatively short-lived bear markets and have a high-risk appetite.
Benefits of investing in bear funds
Though bear funds are high-risk financial instruments, they offer various benefits. The key benefits of a bear fund are listed below:
1. Hedging
Bear funds have an intrinsic property of hedging, which protects you from any kind of downturn in the stock market. Therefore, you can hedge your investment-related risks when the prices of stocks nosedive.
2. Make a profit during a market downturn
Most traditional investment tools make a loss during bear markets. As bear funds depend heavily on short-selling techniques, they tend to bet on falling prices. This helps investors make money from market meltdowns if the expectation of the fund manager comes true.
3. Diversification
The main differentiating feature of a bear fund is its ability to make money for investors when the stock prices are falling. So, when you invest in a bear fund, you are diversifying your portfolio. This ultimately helps you reduce your potential overall risk.
4. Active management of your investment
Bear funds are mostly actively managed by fund managers. This means the person managing your investment can reallocate your funds to different financial tools as per changing market conditions.
Considering the benefits, you should invest in a bear fund. However, it is also important to know all the risks associated with bear funds so that you can make an informed decision.
Risks of investing in bear funds
Bear funds come with several risks. Some of the prominent ones are highlighted below:
1. Market timing
To make a profit from a falling market is tougher than a rising one. This is because bear markets are usually short-lived and last for just one-third of the period as a bull market. So, timing your investment is essential when it comes to bear markets. If the timing is not right, you can make a loss.
2. Short-term focus
If you have a long-term investment strategy, bear funds may be risky as they have a short-term market focus. So, you have to be extremely mindful of when you enter the market and exit to make a profit in the short term. Try to avoid investing in a bear fund for a longer period.
3. Leverage
Bear funds heavily depend on short-selling, which is mostly done through derivatives such as futures and options. These derivative investments are usually leveraged. If the expectations of fund managers don’t match or their timing of entering or exiting is mismatched, the losses will also be significantly leveraged. This is yet another risk that you should keep in mind while investing in a bear fund.
4. Complex strategies
The concepts of short selling and derivatives are complex strategies that novice investors do not understand properly. Implementation of the put option or future short-sell strategies is too complex. It opens up the possibility of making significant losses.
5. Costs
Compared to traditional mutual funds, the costs associated with bear funds are usually higher. This is mainly because they need more active management of portfolios and implementation of complex strategies.
Hence, you should be very cautious while investing in bear funds. You may also consult a financial advisor before investing in these funds.
Also read: Different Types of Investments
When should you consider investing in bear funds?
You should consider investing in bear funds when:
- Economic indicators and market analysis indicate an upcoming bear market.
- The markets are at their all-time highs, and several financial indicators indicate the overvaluation of stocks. Once the market reaches such a position, it is usually followed by heavy selling of stocks and market corrections. Market highs can be an opportune time to invest in bear funds.
- You can consider using bear funds to hedge your risks against short-term market corrections or market dips.
To make the right decision and choice of investing in a bear fund, you should always conduct thorough research of the market and titrate the situation with your risk appetite, personal investment goals, time horizon of investments, and other factors.
You should check the following 5 points if you are still not sure how to consider investing in bear funds:
1. Assessing market conditions
You should analyse various key indicators to assess the market condition. Some of the most important indicators are:
- Economic indicators (such as GDP growth rate, inflation data, rate of unemployment, etc.)
- Market valuation metrics such as P/E ratios and other technical analysis parameters.
- A rise in interest rates can result in market corrections but can sometimes lead to a prolonged bear market.
- Geopolitical events such as wars, disputes on trade among countries, or political instability in a country can cause the market to crash or enter a bear market.
- A dip in corporate earnings may lead to downturns in the market.
- Monitoring all these factors regularly would help you make an informed decision on investing in bear funds.
2. Economic indicators
Bear funds help you make money when the market is moving downward. To make a decision, you may check multiple economic indicators, including stock market trends, high volatility, economic growth, interest rates, inflation, consumer confidence, and unemployment rates. If these indicators signal potential market decline, they make bear funds more attractive to investors.
3. Technical analysis
You may check various technical indicators to make the right prediction about the market’s possible direction of movement. Some of the most important ones are moving averages, RSI (Relative Strength Index), MACD (Moving Average Convergence Divergence), price patterns, and volume analysis. These indicators can help you identify potential entry points for bear funds.
4. Geopolitical events
Various kinds of political instabilities can trigger bear markets. Tension along the borders, political instability, deteriorating international relations, and global trade policies can lead the market to tumble and consequently enter a bear market. Monitoring these events can help you assess market sentiment and understand the potential risks associated with investing in bear funds.
For example, the collapse of Lehman Brothers and the global financial crisis of 2008 made the stock market bleed. Recently, an oil export ban by Europe led to a rise in fuel prices across the world.
5. Diversification benefits
If you diversify your investment portfolio, you will reap a wide range of benefits, including risk management, counterbalance during market corrections, reduction in volatility, and an investment in an alternative asset class. Diversification ensures that you are not putting all your eggs in one basket. This ensures that when a bear market prevails, your potential loss gets mitigated.
Strategies for investment in bear market
A market is said to enter a bear phase when the major indices drop by more than 20% from the recent highs. When such a phenomenon happens, it usually triggers a sell-off frenzy. In such a case, traditional investors make a loss. In a bear market, traditional investing strategies can hardly make you money. In such situations, you can use various strategies for investment to mitigate risks, such as dollar-cost averaging, short-selling, remaining invested for a longer period, and identifying overvalued stocks.
Identify assets that increase in price
During bear markets, there are certain assets that have the potential of either increasing price or maintaining value. Some of them are listed below:
- Gold, silver, and other precious metals
During a bear market, the stock prices fall. Gold and silver are considered to offer stability to investments. Therefore, they are considered safe havens for parking money during adverse conditions. That is the reason why the prices of gold, silver, and other precious metals increase during a bear market, geopolitical instability, etc. - Government bonds
Government securities are considered a safe haven for investing money during bear markets because they are considered low-risk financial assets. They provide you decent returns even in adverse market conditions and essentially preserve your principal investment amount. - Defensive stocks
The essential services sectors, such as healthcare, utilities, and consumer durables, are considered to be more stable than other sectors in bear market conditions. So, try to choose company stocks from these sectors as they have a higher probability of holding up better during adverse conditions. - Inverse ETFs
These funds follow major indices, but their value is inversely proportional. When the value of indices falls during a bear market, the value of these inverse ETFs rises. It not only hedges your downward risk but also provides robust profit in the worst of the bear market conditions. - Be patient with retirement funds
Retirement funds are long-term investments. So, when their value declines during long-term investments, it is a temporary phenomenon. Be patient, as the rough weather will pass. This is because bear markets are short-lived, which has been proven historically over the years. In fact, during bear market conditions, you can continue your regular contributions, allowing you to buy more shares at lower prices. So, when the bear market is over and the prices start increasing, it will set the stage for potentially explosive growth. - Purchase short and long put options
You can long put options during a bear market because it gives you the right to sell a stock at a predetermined price. As the price falls as per expectation during the bear market, it opens up the opportunity to make a profit by squaring off your position with the long put option. You may also short a put option. It essentially means selling a put option. If the stock price remains above the strike price of the put option, it will be a profitable proposition for you. Whether you long or short a put option, this is not for novice investors.
Should you invest in bear funds?
Whether you should invest in a bear fund or not depends on many factors, including your risk profile. Usually, a bear fund uses derivative trading, short-selling, and other techniques to make profits in adverse market conditions.
If you have a negative outlook on the market and want to hedge your risk of downward price movement, bear funds can help you achieve that objective. In fact, it can make money for you as the market tumbles.
Before you invest, you must know that these funds are very risky as they heavily depend on short-selling strategies. As they are high-risk-high-return funds, you must have a high-risk tolerance level to invest in them. You may consult a financial advisor before making any investment decision in a bear fund.
Key takeaways
- A bear fund is a specialised mutual fund that has been designed to provide investors with higher returns when the market is facing a downturn.
- These specialised funds follow an index and track it inversely.
- It is important to note that bear funds have performed poorly historically.
- A bear fund can be attractive if you are looking for short-term investment gains. A debt fund can also work wonders for investors looking for opportunities to hedge their exposure risks to market downturns.
Summary
A bear fund is a strategic financial tool that helps you profit from a fall in market prices. These specialised mutual funds bet on market declines and use short-selling techniques to make money for their investors. Bear funds can be a valuable component that can diversify your investment portfolio, thereby hedging against loss.
Though they offer excellent returns, you should be extra careful before investing in mutual funds, especially a bear fund. You may explore 1000+ mutual fund schemes on the Bajaj Finserv Mutual Fund Platform. Compare mutual funds by calculating their probable returns using a mutual fund calculator before investing.
