Forget About Hedge Funds

by Alan Lavine and Gail Liberman

Enough is enough. Mutual fund companies are coming out with so-called "hedge funds" designed to limit losses in the stock market.

Fidelity Investments, Citigroup, Merrill Lynch and Charles Schwab are just a few major financial firms launching hedge funds for the little guy.

So where were they a few years ago when these types of investments were needed? The funds didn't exist because people were buying high-flying growth funds and technology stock funds.

Now that people have lost their shirts, these new style funds should sell. That's why your friendly investment company sells them.

So what are hedge funds? Before these new mutual funds, hedge funds were loosely regulated investments limited only to wealthy "accredited" investors, required to invest a minimum of $1 to $5 million. Typically, if a traditional hedge fund does well, the manager stands to get 25 percent of the profits.

However, now highly regulated open-end mutual funds are borrowing similar investment tactics used in these exclusive hedge funds. They strive for positive returns in up and down markets. How do they do that?

They buy well-regarded stocks and hope to sell them at a profit. They also sell weak stocks short. That means they profit when the stock prices drop. Other types of hedge funds try to make profits on mergers and acquisitions or in convertible bonds.

Most of these funds are called "Market Neutral" or "Long Short" funds. But they may not be what they are cracked up to be. "Will the  stock picking system pick the right stocks?" asks Brian Lund, analyst with Morningstar Inc., Chicago. "The hedge fund industry record is not conclusive."

Lund says not all hedge funds are alike. So if you pick the wrong one, it may do nothing to reduce your risk of losing money. The analyst adds that the track record of market neutral hedge funds, such as the Premier Market Neutral Fund, Legg Mason Market Neutral Fund, Heartland Contrarian Fund and the AXA Rosenberg Value Fund, produced none of the steady, low-volatility returns they promised. The wide disparity in the results of these funds does not make the sector dependable.

So what should you do to hedge against loss? Keep it simple and stick with stocks, bonds and cash. Lund says you probably don't need the hedge funds.

Alan Lavine and Gail Liberman are husband-wife personal finance columnists, journalists and authors. They are the authors of "The Complete Idiot's Guide to Making Money with Mutual Funds," 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.

More articles by Al and Gail can be found here.