I have spent years analyzing investment vehicles, studying market behavior, and helping investors navigate volatile conditions. One question I hear often—especially during market downturns or periods of uncertainty—is whether mutual funds exist that engage in short selling. The short answer is yes, but the full story is more nuanced. Not all mutual funds short stocks, and those that do operate under specific mandates, regulatory frameworks, and risk profiles.
Table of Contents
What Does It Mean to “Short” a Stock?
Before diving into mutual funds, let’s clarify what shorting means. Short selling is a strategy where an investor borrows shares of a stock, sells them immediately, and hopes to buy them back later at a lower price. If the price drops, the investor profits from the difference.
The profit from a short position can be expressed as:
Profit = (P_{short} - P_{buy\ back}) \times Q - FeesWhere:
- P_{short} = price at which the stock was sold short
- P_{buy\ back} = price at which the stock was repurchased
- Q = quantity of shares
- Fees = borrowing costs, commissions, and dividends paid to the lender
For example, if I short 100 shares of XYZ Corp at $50 per share and later buy them back at $30:
Profit = (50 - 30) \times 100 = \$2,000But if the stock rises to $70, my loss is:
Loss = (50 - 70) \times 100 = -\$2,000Unlike long positions, where the maximum loss is limited to the initial investment, short positions carry theoretically unlimited risk because a stock’s price can rise indefinitely.
This asymmetry makes shorting a high-risk strategy, which is why not all investment vehicles allow it.
Can Mutual Funds Short Stocks?
Yes, some mutual funds do short stocks, but they are the exception, not the norm.
Most traditional mutual funds—such as those offered by Fidelity, Vanguard, or T. Rowe Price—are long-only. Their investment mandate restricts them to buying and holding securities. They aim to grow capital by participating in market appreciation, not by betting against it.
However, a subset of mutual funds is permitted to use short selling as part of their strategy. These are typically classified as:
- Long/Short Equity Funds
- Market Neutral Funds
- Absolute Return Funds
- Bear Market Funds
These funds are often structured as unleveraged or limited leverage vehicles, meaning they may short a portion of their portfolio while maintaining long positions elsewhere.
The Securities and Exchange Commission (SEC) allows mutual funds to short under certain conditions. According to Rule 18f-4 under the Investment Company Act of 1940, registered funds—including mutual funds—can use derivatives and short selling, provided they comply with risk management requirements, including the Value at Risk (VaR) test and board oversight.
This regulatory shift, finalized in 2020, made it easier for mutual funds to engage in shorting and other derivative strategies, though many still choose not to due to complexity and investor expectations.
Long/Short Equity Mutual Funds: How They Work
Long/short equity funds aim to generate returns regardless of market direction. They do this by holding long positions in stocks they expect to rise and short positions in stocks they expect to fall.
Suppose a fund has $100 million in assets. It might:
- Go long $70 million in undervalued stocks
- Short $30 million in overvalued stocks
- Hold $10 million in cash or bonds
This results in a net exposure of 40%:
Net\ Exposure = Long\ Exposure - Short\ Exposure = 70\% - 30\% = 40\%The fund is not fully exposed to market swings. It benefits if its long picks outperform and its short picks underperform.
Let’s illustrate with a simplified example.
Example: Performance of a Long/Short Fund
| Position | Investment | Expected Return | Actual Return |
|---|---|---|---|
| Long: Tech A | $70M | +15% | +12% |
| Short: Retail B | $30M | -20% (short profit) | -25% |
| Cash | $10M | 0% | 0% |
Return from long position:
70M \times 0.12 = \$8.4MReturn from short position:
Since the shorted stock fell 25%, the fund gains 25% on the $30M short:
Total profit:
\$8.4M + \$7.5M = \$15.9MTotal return:
\frac{15.9M}{100M} = 15.9\%Even though the market may have been flat or down, the fund delivered a strong return by combining long and short bets.
This strategy is market agnostic. It seeks alpha—the excess return above the market—rather than beta, or market correlation.
Comparison: Long/Short Mutual Funds vs. Hedge Funds
Many investors assume that only hedge funds short stocks. That’s mostly true for traditional hedge funds, but mutual funds now offer similar strategies with greater transparency and lower fees.
Here’s a comparison:
| Feature | Long/Short Mutual Fund | Hedge Fund |
|---|---|---|
| Regulation | SEC-regulated, daily pricing | SEC-registered (Form ADV), less frequent pricing |
| Minimum Investment | $1,000–$5,000 | $100,000–$1M+ |
| Liquidity | Daily redemption | Quarterly or longer lockups |
| Fees | 0.8%–1.5% expense ratio | 2% management + 20% performance fee |
| Transparency | Monthly holdings disclosure | Limited or no disclosure |
| Leverage | Limited (typically < 30%) | High (often 2x–5x assets) |
| Shorting Allowed | Yes, under Rule 18f-4 | Yes, core strategy |
Source: SEC, Morningstar, Preqin (2023)
As you can see, long/short mutual funds offer a more accessible way to gain exposure to shorting strategies. They are ideal for retail investors who want bearish exposure without the high barriers of hedge funds.
However, they are not as aggressive. Hedge funds can use leverage, complex derivatives, and concentrated bets. Mutual funds must adhere to diversification rules and risk limits.
Bear Market Mutual Funds: Designed to Profit from Declines
Another category is bear market mutual funds. These are explicitly designed to deliver positive returns when the market falls.
They achieve this by:
- Shorting broad market indices
- Using inverse ETFs or derivatives
- Holding cash and defensive assets
One example is the Rydex Inverse S&P 500 Fund (RYURX), which was launched to provide the opposite return of the S&P 500. If the S&P 500 drops 2% in a day, RYURX aims to rise 2%.
However, RYURX was closed in 2013. Why? Because bear funds are hard to market. Investors rarely want to own a fund that profits when the economy suffers. Also, over time, the stock market trends upward. A fund that bets against it tends to lose money in the long run.
Still, a few bear market funds exist today. For example:
- Grayscale Short Volatility Fund (GSVIXX) – targets volatility declines
- ProShares UltraShort S&P500 (SDS) – this is an ETF, not a mutual fund, but often confused
Wait—SDS is an ETF. That’s an important distinction.
Most bearish, shorting, or inverse funds today are exchange-traded funds (ETFs), not mutual funds. ETFs have more flexibility in using derivatives and leverage.
So while mutual funds can short, ETFs dominate the short and inverse space.
Why Are There So Few Shorting Mutual Funds?
Several factors limit the number of mutual funds that short:
1. Investor Expectations
Most investors buy mutual funds to grow wealth over time. They expect exposure to rising markets. A fund that shorts stocks may confuse or alarm them.
Imagine explaining to a 65-year-old retiree that her mutual fund profits when Apple stock crashes. That’s a tough conversation.
2. Regulatory and Operational Complexity
Shorting requires borrowing shares, paying fees, managing dividends, and monitoring margin. Mutual fund custodians and administrators are not always set up for this.
Rule 18f-4 helps, but it also requires funds to implement a derivatives risk management program, including stress testing and board reporting.
3. Tax Inefficiency
Shorting can generate short-term capital gains, which are taxed at ordinary income rates (up to 37% federally). This is less tax-efficient than long-term gains, taxed at 0%, 15%, or 20%.
Also, when a fund shorts a dividend-paying stock, it must pay the dividend to the lender. This reduces returns and creates a tax liability.
4. Market Bias
U.S. equities have delivered an average annual return of about 10% over the long term. Betting against the market is a losing strategy over time. Even skilled short sellers struggle to maintain consistent profits.
Hedge funds that focus solely on shorting—like those that bet against Enron or Lehman Brothers—often close because opportunities are rare and timing is difficult.
Real-World Examples of Mutual Funds That Short
Despite the challenges, a few mutual funds do engage in short selling. Here are three real examples:
1. Tweedy Browne Global Value Fund (TBGVX)
This fund combines deep value investing with modest shorting. As of 2023, it shorted about 5% of its portfolio, focusing on overvalued international stocks.
In its annual report, Tweedy Browne stated:
“We may sell securities short when we identify companies whose securities are significantly overvalued relative to our estimate of intrinsic value.”
The fund’s long-term return has been solid, but not market-beating. Its 10-year annualized return was 6.2%, versus 9.1% for the MSCI World Index.
The shorting component likely reduced volatility but also capped upside during bull markets.
2. Harbor Capital Appreciation Fund (HACAX)
HACAX is a long/short fund managed by Harbor Capital Advisors. It typically maintains 20–30% short exposure.
In 2022, when the S&P 500 dropped 19.4%, HACAX fell only 8.3%. The short positions helped cushion the loss.
The fund uses a fundamental analysis approach, shorting companies with weak balance sheets or declining earnings.
Expense ratio: 0.99%
Minimum investment: $2,500
Short exposure: ~25% (varies)
3. FPA Crescent Fund (FPACX)
One of the oldest long/short mutual funds, launched in 1993. It combines equity, fixed income, and short selling to generate positive returns in all market environments.
As of 2023, FPACX had about 20% of assets in short positions, primarily in overvalued sectors like technology and consumer discretionary.
The fund’s 25-year annualized return was 7.8%, with lower volatility than the S&P 500.
What sets FPACX apart is its flexibility. It can shift from 50% net long to 50% net short based on market conditions.
This dynamic hedging makes it a true absolute return fund.
How Do These Funds Disclose Their Short Positions?
Mutual funds are required to disclose their holdings quarterly via Form N-CSR or N-Q filings with the SEC.
However, they don’t always break out short positions clearly. You may need to read the footnotes.
For example, in FPACX’s 2023 Q2 report, it listed:
- Total long positions: $1.2 billion
- Total short positions: $300 million
- Net assets: $1.0 billion
This implies a gross exposure of 150% and a net exposure of 90%:
Gross\ Exposure = \frac{1.2B + 0.3B}{1.0B} = 150\% Net\ Exposure = \frac{1.2B - 0.3B}{1.0B} = 90\%Some funds report short exposure as a percentage of net assets. Others list short positions in a separate schedule.
Morningstar and Bloomberg also estimate short exposure for many funds, though with a lag.
Mathematical Risks of Shorting in Mutual Funds
Shorting introduces unique risks. Let’s model them.
1. Unlimited Loss Potential
As noted earlier, a short position has no ceiling on losses. If a stock goes to zero, the maximum gain is 100%. But if it doubles, the loss is 100%. If it quadruples, the loss is 300%.
Let P_0 be the initial short price. The return on a short position is:
Return = \frac{P_0 - P_t}{P_0}If P_t = 2P_0, return = -100%
If P_t = 4P_0, return = -300%
Compare this to a long position:
Return = \frac{P_t - P_0}{P_0}Maximum loss: -100% (if stock goes to zero)
This asymmetry makes shorting riskier.
2. Short Squeeze Risk
A short squeeze occurs when a heavily shorted stock rises, forcing short sellers to buy back shares to cover losses, which drives the price even higher.
For example, in 2021, GameStop (GME) surged from $20 to over $300 in weeks. Hedge funds that shorted it lost billions.
A mutual fund with a 10% short position in GME would have seen a 1,400% loss on that portion:
\frac{20 - 300}{20} = -14 = -1400\%Even if the rest of the fund was stable, this could wipe out years of gains.
3. Borrowing Costs and Dividends
To short a stock, a fund must borrow it from a broker. The cost varies.
- For liquid stocks: 0.5%–2% annual fee
- For hard-to-borrow stocks: 10%–50% or more
Additionally, if the stock pays a dividend, the short seller must reimburse it.
Suppose a fund shorts $1 million of a stock that pays a 3% dividend. It must pay $30,000 annually to the lender, reducing returns.
If the stock also has a 5% borrow fee, total cost = 8% per year.
The fund must overcome this drag just to break even.
Shorting vs. Buying Inverse ETFs: A Practical Comparison
Many investors ask: Why not just buy an inverse ETF instead of a shorting mutual fund?
Inverse ETFs like SH (ProShares Short S&P500) or PSQ (ProShares Short QQQ) are designed to deliver the opposite of an index’s daily return.
For example, if the S&P 500 falls 1% today, SH rises 1%.
But there’s a catch: inverse ETFs are reset daily. Their returns do not compound linearly over time.
Let’s illustrate.
Example: 3-Day Market Movement
| Day | S&P 500 Return | SH (Inverse) Return |
|---|---|---|
| 1 | +10% | -10% |
| 2 | -10% | +11.11% |
| 3 | +10% | -10% |
Final value of S&P 500:
1.0 \times 1.10 \times 0.90 \times 1.10 = 1.089 → +8.9%
Final value of SH:
1.0 \times 0.90 \times 1.111 \times 0.90 = 0.899 → -10.1%
Even though the S&P 500 ended up 8.9%, SH lost 10.1%. This is due to volatility decay.
The mathematical reason is that percentage changes are multiplicative, not additive.
For a two-day swing:
Final\ Value_{ETF} = (1 - R_1) \times (1 + R_2) Final\ Value_{Index} = (1 + R_1) \times (1 - R_2)If R_1 = R_2 = 0.10, index ends at 0.99, ETF at 0.99, but in opposite directions.
But with three days of volatility, the mismatch grows.
This makes inverse ETFs poor long-term holdings. They are best for short-term tactical bets.
In contrast, a long/short mutual fund doesn’t suffer from daily reset risk. It holds actual short positions, so its returns compound normally.
Thus, for investors seeking sustained bearish exposure, a mutual fund may be more appropriate than an inverse ETF.
Tax Implications of Shorting in Mutual Funds
Taxes matter. Shorting in a mutual fund generates short-term capital gains, which are taxed at ordinary income rates.
Suppose a fund shorts a stock for 60 days and makes a 5% profit. The gain is short-term.
If you’re in the 32% tax bracket, you keep only 3.4% after taxes.
Compare that to a long-term gain in a traditional fund, taxed at 15%: you keep 4.25%.
Additionally, the fund’s dividend payments (to cover shorted stocks) are not tax-deductible to shareholders. They reduce NAV and are treated as expenses.
In a taxable account, shorting mutual funds are less efficient than long-only funds.
For this reason, investors often hold such funds in tax-advantaged accounts like IRAs.
However, there’s a caveat: the IRS prohibits certain types of shorting in IRAs, such as naked options. But shorting stocks via a mutual fund is allowed.
Always consult a tax advisor.
Who Should Invest in Shorting Mutual Funds?
These funds are not for everyone. They suit specific investor profiles.
Ideal Candidates:
- Sophisticated investors who understand market mechanics
- Portfolio diversifiers seeking low-correlation assets
- Risk-managed investors who want downside protection
- High-net-worth individuals using them in a broader asset allocation
Poor Fits:
- Beginners who don’t understand shorting
- Long-term buy-and-hold investors
- Those seeking market-matching returns
- Investors in high tax brackets with taxable accounts
I recommend allocating no more than 5–10% of a portfolio to long/short or bearish funds, and only as part of a diversified strategy.
Performance During Market Crises
How do shorting mutual funds perform when markets fall?
Let’s look at 2008.
During the financial crisis, the S&P 500 dropped 37%.
The FPA Crescent Fund (FPACX) fell only 15.6%. Its short positions in financials and housing-related stocks paid off.
Similarly, in 2020, when the market dropped 34% in a month, long/short funds with net short exposure gained.
But in 2021, when the market surged 28.7%, many shorting funds lagged.
This highlights their role: downside protection, not consistent outperformance.
A study by Morningstar (2022) found that over 15 years, long/short equity funds returned 6.4% annually, versus 8.9% for U.S. large-cap stocks. But their standard deviation was 30% lower.
So they traded some upside for reduced risk.
Alternatives to Shorting Mutual Funds
If you want bearish exposure, consider these alternatives:
1. Inverse ETFs
- Pros: Liquid, transparent, easy to trade
- Cons: Volatility decay, not for long-term holding
2. Put Options
- Pros: Defined risk, leveraged exposure
- Cons: Time decay, complex pricing
3. Cash and Bonds
- Pros: Safe, stable, income-generating
- Cons: No upside if market rebounds
4. Hedge Funds
- Pros: More flexibility, skilled managers
- Cons: High fees, illiquid, opaque
Each has trade-offs. Shorting mutual funds sit in the middle: more accessible than hedge funds, more stable than inverse ETFs.
Final Thoughts
Yes, there are mutual funds that short. They are rare, but they exist.
They serve a specific purpose: to reduce portfolio risk, generate returns in falling markets, and provide diversification.
They are not designed to replace your core stock holdings. They are tactical tools.
I use them sparingly in client portfolios—mainly for high-net-worth individuals who want protection without timing the market.
If you’re considering one, read the prospectus carefully. Look for:
- Clear disclosure of shorting strategy
- Reasonable expense ratio
- Experienced management team
- History of risk management
And remember: shorting is hard. Even professionals lose money betting against the market.
But when used wisely, shorting mutual funds can be a valuable part of a balanced investment plan.
References
- U.S. Securities and Exchange Commission. (2020). Final Rule: Margin and Risk Limits for Registered Funds. Release No. IC-34086.
- Morningstar Direct. (2023). Long/Short Equity Fund Category Report.
- Bloomberg Fund Data. (2023). HACAX, FPACX, TBGVX Holdings and Performance.
- FPA Funds. (2023). FPACX Semiannual Report.
- ProShares. (2023). Understanding Inverse ETFs.
- IRS Publication 550 (2023). Investment Income and Expenses.
