Avoid Market Neutral Funds

by Alan Lavine and Gail Liberman

What the heck are market neutral mutual funds? These are funds that try to profit by offsetting stocks that are expected to rise in value with stocks that are expected to drop in value.

There are a fistful of these types of mutual funds. But performance data by Morningstar Inc., Chicago, show these funds fail to deliver on their promise--returns that are independent of the stock market.

Richard A. Ferri, author of “All About Asset Allocation (McGraw Hill),” avoids these funds for a couple of reasons:

• It is difficult to find benchmarks to evaluate market neutral fund performance.  
• Fund expenses are too high. They sport annual expenses ranging from 2 percent to more than 3 percent. That compares with average stock fund expenses of about 1.5 percent of net asset value.
• Market neutral fund returns are inconsistent. They performed poorly during the bull market of the 1990s. There also are large differences in the year-to-year returns among market neutral funds.  
• A mix of stocks, bonds and cash can deliver sufficient risk-adjusted rates of return.

“It is a leap of faith to rely on a portfolio manager to long and short stocks,” says Ferri, a Troy, Mich.-based investment advisor, with $500 million in assets under management. “And the expenses are too high.”

Ferri suggests: If you have a net worth of at least $250,000, you can invest in hedge funds. The reason: Hedge funds have more investment flexibility and fewer investment restrictions than open-end mutual funds. 

What about the average investor? You may be better of sticking with a balanced fund that owns both stocks and bonds. That’s all you need.

Alan Lavine and Gail Liberman are husband-wife personal finance columnists, journalists and authors. They are the authors of "Rags To Retirement," published by Alpha Books. Their columns appear in newspapers throughout New England and the Southeast, as well as online. Their commentary on mutual funds and personal finance is carried by 200 radio stations nationwide every Sunday over Business News Network's Charles DeRose Financial Advisor Show. Al and Gail’s new book is "Rags To Retirement:  Stories from people who retired well on much less than you think," published by Alpha Books.

More articles by Al and Gail can be found here.