It’s time to embrace a prudent bear

With the FTSE 100 down 15% so far this year, it seems a shame that Gartmore Asset Management has decided to shut its ailing UK Bear fund. But for investors looking to play or hedge against falling markets, there are still plenty of options to choose from in the US.

"Designed to prosper in sinking markets", bear funds "are the subject of ridicule most of the time", says Bob Frick in Kiplinger's. But they don't look so funny now that markets are falling. For example, since the start of this year, Direxion NASDAQ-100 Bear 2.5x (NASDAQ:DXQSX) had jumped 55% by mid-March, while the ProFunds UltraShort NASDAQ-100 (NASDAQ:USPIX) is up 44%.

Both funds are inverse trackers; so when a market falls, the value of the fund rises.The examples above also use leverage (borrowing in order to buy more securities) to enhance returns. As its name suggests, the Direxion NASDAQ-100 Bear 2.5x fund aims to rise by 2.5% for every 1% the Nasdaq 100 falls.

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But, of course, it works the other way around as well and at volatile times like these, gains can rapidly become losses. For example, the Direxion fund was down 36% in 2007. "Market-timing bets are extremely risky and have burned many investors in the past", says David Kathman on Morningstar. Non-leveraged ETFs might be better bets, particularly if you want to hedge against falls in your main portfolio.

But if you actually want to invest for a fullblown bear market, it might be worth looking at an actively managed fund, which can be a bit more flexible in its approach. Prudent Bear (NASDAQ:BEARX), the largest bear fund at $1.2bn, not only shorts indices and stocks, but invests in more traditional hedging techniques, such as precious metals. In 2002, when the wider market fell 22%, Prudent Bear rose 63%. Even during the bull market of the past five years it eked out an annualised return of 1% because of its positions in precious metals. With an annual expense ratio of 2.33%, it's expensive. But if the markets continue to tumble, then it could be a very useful part of any portfolio.