Exotic funds are some of the current top performers
— -- As you look at the top-performing mutual funds for the past three months, you'll probably note that the VelocityShares Daily 2X Short-Term VIX ETN came in first, with an astonishing 420% gain.
Your first question: What on Earth is a daily 2X short-term VIX fund?
Good question. The ranks of the top-performing funds are now filled with bewildering names and specialized strategies. Do they belong in your portfolio? Probably not. The market's recent unpleasantness has revealed a few interesting funds that you might want to investigate — but you should avoid most short-term winners.
We can assume that VelocityShares Daily 2X Short-Term VIX ETN didn't get its name accidentally. Mutual fund names, like baby names, tend to be trendy. Funds born in the 1960s, 1970s and 1980s, for example, often have names that denote boldness and discovery: Putnam Voyager, Fidelity Magellan, Mutual Quest, Clipper.
Recent arrivals, however, seem to prefer names that ring of complex hedge-fund strategies. Here's how the name of the VelocityShares Daily 2X Short-Term VIX fund describes what it does.
•VIX: The VIX is the Chicago Board Options Exchange volatility index, sometimes called the Fear Index. It measures the expected volatility of the Standard & Poor's 500 stock index. When the VIX soars, people expect big swings (up or down, but generally down) in the stock market.
•Daily 2X: The fund's share price will rise or fall twice as much in a day as the VIX does.
•ETN: Exchange-traded note. As its name implies, the fund trades on the stock exchange, as a stock does. You can trade it minute by minute, if you like, or even sell it short, which is a bet on falling prices. Unlike exchange-traded funds, however, this is a note: Specifically, it's an obligation of Credit Suisse.
Risks? Plenty, starting with the fact that the ETN's value is subject to the ability of Credit Suisse to pay its obligations when they come due. Credit Suisse is in dandy shape, but betting on bank credit isn't what it used to be. Best quote from the fund's tear sheet: "If you hold your ETN as a long-term investment, it is likely that you will lose all or a substantial portion of your investment."
Many of the other top-performing funds this quarter are short-term trading vehicles such as this. You can make vastly leveraged bets on oil, stocks, regions and even countries. The 3X Kelp fund can't be far behind.
Should you invest in these? Probably not. But nearly all the funds that posted a gain in this wretched quarter had one secret: They either avoided stocks or hedged their holdings with futures, bonds or other types of investments:
•Hussman Strategic Growth fund (ticker: HSGFX), for example, gained 7.3% last quarter, vs. a 14.3% loss for the S&P 500. It uses futures and options to protect against losses when it feels the market is due for a downturn. While management has occasionally hedged itself against gains in bull markets, they apparently called it right this time.
•MFS Diversified Target Return fund (DVRAX), up 3.9%, aims only to beat inflation. The fund bulked up on bonds and cash, and chalked up a modest gain.
•Turner Market Neutral (TMNFX), down 0.2%. The fund buys stocks it likes and sells short those that it doesn't like. The strategy works well in the right hands. Market neutral funds by AllianceBernstein, Zacks and American Century all weathered the third quarter well.
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