If you're the sort of mutual-fund investor who likes to go against the crowd, a couple of financial firms have a proposition for you.
Fidelity Investments of Boston and Jack White & Co. of San Diego have set up operations that allow customers to sell mutual-fund shares short - a tactic that seeks to profit from a decline in the funds' net asset values.This idea might pique the interest of just about anyone with a contrarian disposition, given the boom taking place in the fund industry and the lofty level of stock prices in the funds' portfolios.
If you believe the fund industry might be riding for a fall, this is a way to try to cash in on your convictions. But before you reach for your phone and your checkbook, advisers who specialize in mutual funds have some words of warning to offer.
"We believe most of you should pass on this opportunity," says Sheldon Jacobs in his No-Load Mutual Fund Investor advisory. "Short selling is a form of market timing, but the odds are against you since the market is in a long-term uptrend."
Or as Norman Fosback, editor of the Mutual Fund Forecaster service, puts it, "Short selling is a dangerous game - too dangerous for the vast majority of investors."
Selling short is a practice nearly as old as the history of markets. It works by simply reversing the usual order of buying and selling, to enable a trader to try to play falling prices instead of rising ones.
When you short a stock, you must borrow shares from a broker in order to sell them. Later, at what you hope will be a lower price, you buy an equal number of shares to "cover" your position and return the borrowed stock to the broker.
Except for one or two brief experiments in the past, this option hasn't been available with mutual-fund shares until quite recently.
"For those inclined to chance the short side of the market," Fosback observes, "mutual fund shorting has several attractions, including low commissions, relatively small capital requirements, and the ability to structure short portfolios that encompass either funds that parallel the market or those that closely track specific industry groups.
"Unlike the prime risk of selling short stocks - unlimited loss potential - funds tend to fluctuate within more reasonable limits."
Still, Fosback and other analysts agree, shorting fund shares shouldn't be attempted without a thorough understanding of the many special problems and hazards involved.
For several reasons, it is technically more difficult to take and maintain a short position than a long one in any stock-related investment. One typical disadvantage lies with the dividends paid on stocks and the distributions paid to holders of mutual-fund shares.
"While investors earn dividends, short-sellers have to pay them," Fosback points out. "That's because the person that bought the shares from the short-seller is entitled to dividends just as is the owner of the original shares that were borrowed by the short-seller.
"In other words, two investors are owed dividends, and the short-seller is obliged to pay one."
But the biggest, most fundamental obstacle to all short-sellers in stocks and stock funds is the long-term upward trend of the market.
"The single most attractive aspect of owning mutual funds is that, over time, equity values almost invariably rise - historically about 10 percent per annum on a total-return basis," says Fosback.
"Short-sellers not only give up that 10 percent return but in effect enter into positions in which, all other things equal, their `expected' return is a 10 percent loss."