The Wall Street Journal-20080130-Long-Short Funds Find A Footing Amid Turmoil

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Long-Short Funds Find A Footing Amid Turmoil

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In the past several months, long-short funds stopped coming up short.

The funds, touted for their aim of delivering investment gains in any market conditions, have, for the most part, made good on that promise amid the recent stock-market turmoil.

While that's good news for this new and increasingly popular brand of mutual fund, investors should still take these early returns with a grain of salt.

Among these funds' drawbacks: short track records and mediocre returns when stocks were cruising in 2005 and 2006.

Long-short mutual funds usually combine traditional "long" or bullish bets with "short" or bearish ones that, if placed wisely, allow fund managers to profit even when stocks fall.

While in theory long-short funds could use their extra abilities to make big bets hoping for outsize profits, most use the strategy to try for steady returns during bull and bear markets.

Lately that proposition is looking pretty good. While many long- short funds have suffered somewhat recently, they have fared far better than the stock market as a whole.

Long-short funds are down, on average, about 4.2% over the past three months through Monday, compared with the Standard & Poor's 500- stock index's 11.4% decline, according to Morningstar Inc. The period roughly corresponds to the stock market's plunge from its Oct. 9 high.

In fact, long-short funds have performed better than every other category of stock funds that Morningstar follows during that period, except "bear market" funds, designed specifically to profit when the market falls.

Still, three months is a very short time to judge a fund's performance, even a period as eventful as the past one.

While the long-short funds have held up admirably, their track record wasn't as good the last time the market fell into a swoon in July and August of last year.

Most funds aim to insulate investors over the course of a full bear market -- not a few days or a few weeks, says Morningstar analyst Marta Norton. But that makes the category difficult to judge because so many of the funds are brand new. Only about one-third of the long- short funds Morningstar tracks have a three-year track record. Even fewer have been around for five years.

In part because of the funds' cautious strategies, they have lagged behind the market over the longer three-year period, returning 5%, on average, compared with the S&P 500's 6.9%.

One typical fund, American Century Long-Short Equity, is down by a relatively modest 3% over the past three months. (It is up 2.9% over the past year, the longest standard period for which returns are available.)