All You Need To Know About Inverse Mutual Funds

Inverse Mutual Funds.

We all know about regular mutual funds, but what is inverse mutual funds?

They are a special type of funds in which their value goes up when the stock market comes down. They are nothing but “short funds” or funds having short positions of the index or stocks. By investing in this fund investors/traders can take advantage of fall in the markets.

The main objective of the inverse mutual fund is to provide investors with an alternative during market-decline and in the case where they cannot short sell the index. This type of fund is generally linked to the market index such as the S&P 500 or any other benchmark index.

The value of such funds change similar to the traditional funds, on a daily basis, say if the index declines by 1 percent in a day, the fund value increases by 1 percent for that day.

inverse mutual funds

In what other ways these funds differ from  traditional funds?

While a traditional mutual fund purchases shares of index or stocks, which is income generating in the form dividends, the inverse mutual funds do not purchase the stocks themselves.

Instead, they may short sell the index or stocks or even buy put options on the index or the stocks. Hence, these funds make money only if the particular index or stock falls.

How does these funds benefit retail investors or traders?

Many investors, rather traders, can make use of this type of fund as a hedge against market conditions. During market corrections, investors/traders could buy some shares of an inverse fund in order to protect their long positions in other funds or stocks. This way, even if the market does go down, they will be able to recoup some of their losses on their long positions with the inverse fund.

Disadvantages:

Unlike the traditional funds, there are no dividends in these type of funds. The costs involves are also high since frequent churning of positions required on a day to day basis. They also involve high risks and needs constant monitoring of the fund value and the market direction.

Conclusion:

Investors should deal with Inverse Mutual Funds, only if they completely understand the risks associated with shorting and the returns associated with it. This can be used as short-term strategy only and not as a long-term one.

There are many such funds in developed markets, but there aren’t any such funds in emerging markets like India. Hope some fund house would take some cue from this and launch an inverse fund soon.

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