Posted on: Sunday, July 7, 2002
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To Growl and Bear It: They Did
New York Times - By Carole Gould

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Many mutual funds recorded double-digit losses in the second quarter, with diversified domestic equity funds losing 11.3 percent of their value, on average according to Morningstar, Inc.

So it is not surprising that the top of the winners' list was crowded with so-called bear-market funds that are intended to thrive during stock market declines by using strategies like shorting stocks.

Some of these strategies, however, can create high volatility in share prices, warned Russel Kinnel, director of fund analysis at Morningstar. He recommends looking at the funds' overall track record over time, year by year, or even quarter by quarter, to gauge their riskiness.

Managers of some of the top performers among diversified actively managed funds — bear-market funds or otherwise — talked about the quarter and what they saw ahead for the stock market. Each fund is open to new investors.

A Hybrid of Sorts

The $90 million Comstock Capital Value Class A fund took second place among actively managed diversified domestic equity funds open to new investors, and seventh place over all. The fund rose 22.6 percent in the quarter.

Charles L. Minter, 60, and Martin Weiner, 68, the co-managers, are confirmed bears. "We strongly believe that the stock market will continue down at least another 30 or 35 percent from here," Mr. Weiner said from their offices in Yardley, Pa., outside Philadelphia.

Mr. Minter added: "We're coming off one of the biggest bubbles in U.S. financial history, from the late 1990's to the early 2000's. Everything that's happening now is the result of that inflating bubble."

The fund is classified by Morningstar as a domestic hybrid, which typically owns a mix of stocks and bonds, but Comstock Capital Value has owned no stocks for two years. Instead, it owns United States Treasury bills and bonds and uses a variety of strategies to bet on stock market declines. These include selling stocks short and buying Standard & Poor's 500-stock index futures.

Among its most profitable shorts this quarter was the Manugistics Group, a Rockville, Md., company that makes business management software. The managers sold shares short in early April for about $18, closing the position at the end of June when shares traded at $6.11 and earning a return of 67 percent.

So far, they have made about 92 percent on paper in Broadcom, the semiconductor manufacturer in Irvine, Calif. The managers started selling Broadcom shares short about two years ago when the stock was at $229; it closed the quarter at $17.54.

Small Banks Are the Ticket

The $160 million Eclipse Small Cap Value fund was one of a handful of funds that made money in the quarter by buying stocks. It rose 5.9 percent, placing fourth among diversified funds and 11th over all.

Kathy O'Connor, 42, and Wesley G. McCain, 59, the co-managers, review the smallest 2,000 or so United States companies every week, looking for those that they think are undervalued relative to their history, their industry and other small stocks.

Cheap companies are not enough, Ms. O'Connor said from her Manhattan office; they also want to see improving profits. The fund, which is highly diversified, owns 300 stocks.

Its second-quarter performance was driven in part by its stake in small banks — 17 percent, compared with 14 percent for the Russell Small Cap Value index. Another factor was a relatively small position in technology and communications stocks — less than 2 percent versus 6 percent for the index, Ms. O'Connor said.

Small banks were profitable, she said, because the economics of the business are particularly strong right now; banks are paying interest rates of about 2 percent to depositors and collecting 6 percent interest on their mortgage loans. "A lot of our portfolio companies benefited from consumers' investments in real estate," she said, adding that their best performers were financial services companies, mortgage lenders and home builders.

One winner was Flagstar Bancorp, the holding company for Flagstar Bank, based in Troy, Mich. Flagstar stock, which rose about 49 percent in the quarter, benefited from the strong real estate market in its area, Ms. O'Connor said.

For the same reasons, the fund made money in Brookline Bancorp, in Brookline, Mass., the holding company for Brookline Savings Bank, which operates in Brookline and eastern Massachusetts. It rose 48 percent in the quarter.

Another winner was Novastar Financial, a national mortgage lender based in Westwood, Kan., up 90 percent in the quarter.

Ms. O'Connor says she is not bullish on the market for the short term. "Despite the declines," she said, "market valuations are still historically high because corporate profitability hasn't been catching up."

Counting on Indexes to Fall

The $175 million Hussman Strategic Growth fund rose 3 percent in the second quarter, taking sixth place among diversified domestic equity funds and 16th place over all.

The fund is always fully invested in individual stocks, said John P. Hussman, 39, the manager. But he can hedge away the market risk of the stock portfolio by selling market indexes short related to the stocks. He shorts the Russell 2000 index to offset losses in his smaller stocks and the S.& P. 100 index to offset losses in the bigger stocks.

To decide whether to hedge the fund's stock portfolio, Mr. Hussman uses a computer model to review trends in stock prices and trading volume among individual stocks. He also examines what he calls "uniformity" in the overall market — whether performance among a variety of groups like large- and small-cap stocks, industry sectors and bonds is moving in tandem.

"Market history indicates that overvalued markets don't always decline," Mr. Hussman said. "What distinguishes them in the short term is uniformity across all the stock sectors, which tells you that investors have a robust preference for taking risk in the overall market."

The hedging, Mr. Hussman explained, is intended to smooth the fund's volatility. By the rules in the prospectus, he may hedge the entire portfolio, which he has largely done since September 2000. But he is not permitted to create a net "short" position, meaning he may not sell more shares than he owns.

The fund's second-quarter results, he said, were driven by the fact that the stocks dropped about 9 percent, on average, while the indexes declined about 12 percent, on average, creating a 3 percent return.

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