Quick Take: Declining stock prices aren’t bad news for all money managers. Take David Tice, for example. The Prudent Bear Fund (BEARX) that he oversees is designed to go up when the market is going down.
The $300-million fund sells stocks short. That is, it borrows shares, sells them at a high price, and buys them back more cheaply when they fall. Tice also buys put options: the right to sell a stock at a certain price in the future. Investors who own these pay a premium for the right, expecting that stock prices will fall. While Tice does take long positions, investors should realize that the fund has much more short exposure.
Through today, the fund has returned 55.2% this year, while the Standard & Poor’s 500 Index has lost 21.4%. Prudent Bear topped the index in each of the last two years as well, returning 7.4% in 2001 and 30.5% in 2000. The index lost 11.9% and 9.1%, respectively, in those years.
The Full Interview:
S&P: Given the nature of the fund, what was your reaction to the market’s surge yesterday?
TICE: That was a short-squeeze rally. There are intense rallies inside bear markets, and so it didn’t surprise me. It doesn’t change my view.
S&P: I take it you don’t think stocks are out of the woods yet?
TICE: Not at all. This has been a stock market and economic bubble, and a ramification of a stock market bubble that breaks is a bear market that will last a long period of time.
The market is still selling at 30 times earnings, and many Nasdaq stocks are still selling at seven times sales.
In addition, we have an economy that is dramatically over-leveraged on the consumer and on the business side. We’ve had a small recession and, unfortunately, we’re going to have a much worse recession.
S&P: Why will it worsen?
TICE: There’s over capacity throughout businesses and we have a falling dollar that we think is going to continue to fall.
S&P: Have we seen the last of the corporate accounting and governance scandals that have hurt stocks?
TICE: They’re going to be around for a long time. That’s consistent with our view that what we had was an environment where the most reckless, aggressive executives were promoted, and they pulled out all the stops to meet earnings per share expectations so that momentum stock investors could continue to buy their stocks.
S&P: What do you think the price-to-earnings ratio for the market should be?
TICE: Generally, about 15. That’s been the long-term average multiple of stocks over the last 100 years, or so.
S&P: Can you summarize how the fund works?
TICE: We were set up to make money in a down market. We primarily sell stocks short and we own put options.
We have a team of analysts that help us analyze balance sheets, income statements, cash flow statements, and real estate investment trust footnotes. We call competitors.
S&P: What size companies do you buy?
TICE: On long positions, we typically buy companies with market caps of under $300 million. On the short side, we’re all over the map.
We have about 150 short positions right now, and about 50 long. That’s typical. That number of stocks gives us diversification. I can’t talk about the largest holdings, however.
S&P: How are the fund’s assets allocated right now?
TICE: We’re at about 50% in short positions. That’s a little lighter than normal, because we had been expecting this rally.
Put options account for about 7% of the fund. These wind up creating a synthetic short position of about 30%. We’re at about 15% long and about 25% in cash.
S&P: What’s the breakdown for your short positions?
TICE: That varies, based on the market environment. We are heavily short financial stocks (banks, credit card companies, brokerage houses). We’re also short a number of technology companies that we believe are still dramatically overvalued. Even though there’s been quite a correction, we have a long way to go in that area.
S&P: What helped your performance in the second quarter?
TICE: Obviously, the fact that we were short when the market was going down. That helped the most. Gold stocks also helped. Being short technology and telecommunications stocks at the right time helped, too. Financial stocks have also helped us a lot in the last month.
S&P: What do you like about gold stocks?
TICE: Gold normally does very well at the tail end of a pierced bubble. And we think gold will do very well in either an inflationary or a deflationary environment.
S&P: Where do you see tech and telecom stocks heading in the short term?
TICE: Lower still. Stocks are still too expensive across the board, and expectations are too high.
S&P: What about spending on information technology?
TICE: It will be lower with corporate profits going down, and technologically, companies don’t need to buy new PCs.
S&P: What do you do to boost the fund’s performance when the market’s going up?
TICE: We buy some call options. We reduce our short exposure. Our long positions don’t necessarily work when the market’s going up, so we don’t necessarily increase them.
S&P: Who is a fund like yours suitable for — what kind of investor?
TICE: Really, anybody. The fund lets people reduce their exposure to the market, and by cutting risk and being less long — by having short exposure — you essentially set yourself up to make less money if the market goes up, but to lose less money if the market goes down.
S&P: How do you feel personally when stocks drop?
TICE: We’re sad for our friends and family and naive people that are being hurt by this market decline, so we are never gleeful about it.