Which Long-Short Funds Pass a Simple Stress Test?
Here is a quick and easy way to find some interesting "alternative" options.
An investor looking to add a long-short fund to his or her portfolio needs to do extra homework. After all, the category represents a fairly eclectic group: Some strategies can be appropriate core holdings for risk-averse investors, while others are more sensitive to stock price movements and might provide less of a cushion in a downturn. Whether you're looking for a portfolio complement or an anchor, the Morningstar Premium Fund Screener can help you find some initial possibilities. But in order to understand which long-short fund is right for you, you'll have to dig deeper. Morningstar Fund Analyst Reports are a good source to help you understand how these funds have fared during various market cycles as well as what role each could play in your portfolio.
Given the wide range of strategies at play, we searched for long-short funds with five-year records that came out ahead of the category average during that time frame. And because style and management consistency should be a top priority, we made sure that the current management team was responsible for the five-year record. Lastly, it's key to limit the results to funds with below-average fees. Funds in this category tend to sport some pretty hefty expense ratios, especially those with smaller asset bases or more trading-intensive strategies.
The Premium Screener recently pulled the following funds meeting these criteria:
Calamos Market Neutral Income (CVSIX)
Caldwell & Orkin Market Opportunity (COAGX)
Diamond Hill Long-Short (DIAMX)
Hussman Strategic Growth (HSGFX)
Vanguard Market Neutral (VMNIX)
To run the screen yourself and get the most recent results, click here.
One of the most reasonably priced options on this list is Hussman Strategic Growth (HSGFX). In fact, it was one of the cheapest options in its category even before the fund's board decided to slash its expense ratio from 1.10% to 1.04% annually. Manager John Hussman analyzes market conditions by keeping tabs on price trends, trading volume, and valuation measures, and he then makes decisions on the most attractively priced stocks. In addition, he uses put and call options on the S&P 500 Index to hedge the portfolio when his market outlook is gloomy, or he can simulate 150% market exposure through call options when things look rosier. Hussman was able to limit the fund's losses in 2008 to 9%, putting it in better standing than two thirds of other long-short strategies. More importantly, the strategy has delivered over the long term. Its 2.9% average yearly return in the past five years beats the S&P 500's results by more than 2 percentage points.
Our only Analyst Pick in this category is Gateway (GATEX). Patrick Rogers invests this portfolio's assets in a broad basket of stocks that reflects the S&P 500 Index. He simultaneously sells call options and buys put options on the index depending on the price of volatility. When the market dips, the call options make money, which mitigates some of the stock losses. Buying index put options also provides protection from large market declines. However, when volatility spikes, these puts get expensive, and Rogers won't write puts on 100% of the portfolio. While this strategy limits upside--the bogy is up 16% for the year to date ended Oct. 1, 2009, while this fund has gained 2.5%--it's certainly an attractive proposition for risk-averse types. In 2008, the fund's 14% loss represented just 40% of the broad market's, which is precisely what the fund is designed to do.
At Calamos Market Neutral Income (CVSIX), two distinct strategies combine to provide solid risk-adjusted returns. Manager John Calamos relies on covered call writing, which involves selling calls on the S&P 500 Index as well as muting downside risk through index puts. And to a lesser extent, Calamos uses convertible-arbitrage, which seeks to exploit mispricing in convertible bonds while offsetting some equity risk by selling the related stock. Last year, the convertible market blew up in part because of forced selling by hedge funds, contributing to this fund's 13% loss. That said, continued market volatility in 2009 has boded well for the covered call strategy, and the fund has posted a healthy 10% gain for the first three quarters of this year. Investors looking to diversify the risk of their equity holdings should consider this fund as a portfolio complement. The firm's expertise in convertibles investing argues strongly in its favor, and we think that it can continue to provide solid long-term results.
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Karin Anderson does not own (actual or beneficial) shares in any of the securities mentioned above. Find out about Morningstar’s editorial policies.