by Cynthia Harrington

After three years of negative stock market returns, advisors want some relief. Mutual fund companies offer up a possible alternative with market-neutral strategies and funds that short the market.

Until recently only the very wealthy had access to hedged strategies, which required a $1 million average minimum investments and accredited investor status. Now Securities and Exchange Commission-registered, open-ended funds offer long-and short-leveraged returns and market-neutral strategies for $25,000 minimums.

But that initial hurdle might have to drop to zero before some advisors would buy in. "Until the recent bear market, the market-neutral funds didn’t shine,’ said James A. Shambo, CPA/ PFS, of Lifetime Planning Concepts, in Colorado Springs, Colo. "When I consider the market is up seven years for every three-year decline, I want to be generally on the long side of equities.’

Market-neutral strategies seek to provide consistent annual returns independent of the trend of market indexes. An example is the Calamos Market Neutral Fund that hedges outright ownership of convertible bonds by shorting the underlying common stock. The three-year performance of this fund illustrates Shambo’s assertion.

In 1998 and 1999 Calamos Market Netural returned 10 percent and 13.7 percent, 18.5 percent and 7.4 percent behind the S&P 500. In 2000, this fund crunched out the similar 10.3 percent return, but trounced the S&P 500 by 19.4 percent.

Advisors committed to long-term allocation strategies with annual rebalancing strategies are not likely to be attracted to hedged mutual funds. Advisors looking to rebalance more frequently or those who employ market timing are the biggest audience for one fund family’s offerings. "There are a growing number of advisors that have come to the realization that they need to pay more attention to the clients’ investments than in the past,’ said Kirk Oberfeld, vice president of marketing and communications for ProFunds, in Bethesda, Md. "These advisors use our funds to hedge exposure to markets for a period of time, or to rotate among sectors when their indicators change.’

ProFunds offers a menu of indexed funds, including several sector funds and traditional growth and value-style funds from popular market indexes. Additionally they provide index based funds designed to magnify either up or down movements in the market indexes. Their Bear ProFunds’ stated objective is to "to match or double the inverse [opposite] of an index’s performance.’ Based on both the S&P 500 and the Nasdaq indexes, these funds seek to move in the opposite direction by an equal amount or by double the move in the stated market index.

Advisors pick these strategies to further diversify clients’ portfolios. "It really does allow me to do complete portfolio allocations,’ said Lewis Perkins, MBA, CFP, of Financial West Group, in Santa Monica, Calif. "I used the Rydex Fund Family bear fund. Bear funds being up in 2001 balanced off the losses in the long equity assets.’

Investors with long-term strategies question the ability to time the market successfully. Shambo works now with an investor whose assets lightened by 60 percent in the early 1990s. "He was convinced the market was going down and committed large amounts to the funds that shorted the market,’ said Shambo. "He missed the biggest bull market in history by needing to be right and on one side of the market.’


Alternative investments like hedged funds offer the attraction of diversification even to non-market timers. Shambo puts a small piece of client assets into managed futures. The Mount Lucas Mountain Trust offers a leveraged or non-leveraged portfolio of investments in currencies, pork bellies and precious metals. "The MLM Index is completely outside the equity markets,’ explained Shambo.

There’s another limitation with using even the SEC-registered hedge funds. These choices haven’t yet made broad inroads in the 401(k) market, which encompasses a growing percentage of many clients’ portfolios. While available through some broker-dealers for purchase in self-directed IRAs, the funds are largely offered through the very large broker-dealers and registered investment advisors.

"We’re marketing these funds the same as all our offerings,’ said Oberfeld. "We use purely face-to-face marketing with our reps calling on advisors and distributors.’

ProFunds sees growth in another area that helps advisors plan for client retirement. Increasingly, their bear and bull funds appear in variable annuities and variable life policies. American Skandia, ING, Jefferson Pilot and Canada Life are some of the companies including the index-based funds inside insurance products.

Shorting the market or using leverage for the upside aren’t the only ways to hedge portfolios. "I manage exposure by not committing too big a percentage to any one class,’ said Shambo.

Perkins constantly searches for the smartest money managers. One currently initiated arbitraged positions between preferred issues of REITs and Treasuries. "As interest rates rise, the spread will narrow and investors will pocket the difference,’ he explained.

Other strategies offer investors counter-market moves. Perkins points to the housing boom and skyrocketing gold prices as possible harbingers of inflation. He’s buying oil companies as a hedge against that event. Within oil companies he looks for situations that give one company an edge. "I bought BP/Amoco for clients because they’re also the largest solar enterprise in the world,’ said Perkins.

Another hedge against market fluctuations is the payment of a current dividend. Small bank stocks offer yields in the 3 percent to 4 percent range. "At 10 to 13 times earnings, these companies are conservatively valued in addition to my current payment,’ said Perkins.

The new hedged mutual funds might be getting a lot of press compared to the size of their audience. Advisors who like to move client assets frequently and market timers who know how to beat the market will be thrilled to find these funds with lower minimums. But advisors committed to long-term, strategic portfolio management will be a hard sell.

Even advisors like Perkins who make calls on the market may come and go with the funds offering short positions on the market. "I have to find a way to make money for clients in all market environments,’ he said. "Now I think it’s too late to short the market as a hedge. It already went down.’

Register or login for access to this item and much more

All Accounting Today content is archived after seven days.

Community members receive:
  • All recent and archived articles
  • Conference offers and updates
  • A full menu of enewsletter options
  • Web seminars, white papers, ebooks

Don't have an account? Register for Free Unlimited Access