Want Safety? 'Market-Neutral' Funds Offer Long and Short of It

Investors bucked and bruised by the wild ride with equities might saddle up some "market neutral" funds to break the market bronco.

The funds deploy a tested hedging technique to tame market volatility while still yielding decent returns. They appear ready-made for Wall Street, 1998.

The idea is to balance investments in promising stocks with short sales of overvalued stocks. A short sale attempts to profit when a stock falls in price. (The investor doesn't own the stock, but makes an agreement to sell the stock at a future date and counts on being able to buy it before then below its current price.)

In bull markets, the strong stocks make up for losses among the shorts. In bear markets, the shorts gain more than the stocks lose.

"We have a portfolio that cancels our market risk," says Steven Dean, a manager of the newly opened Barr Rosenberg Market Neutral Fund.

Another, similar Barr fund shows an 18 percent annual return, before expenses, for the past three years. That hardly matches stock-market indexes, but the risk parallels an intermediate-term Treasury bond, Mr. Dean says.

The fund has some wrinkles: Annual turnover is about 200 percent; expenses run a whopping 2.5 percent of assets. The high figures stem partly from rapid-fire use of computer models to guide the fund into about 300 long and 300 short positions.

Investors are unlikely to hit a grand slam with a market-neutral fund.

"By definition, you can't expect huge returns," says Russ Kinnel, domestic-equity editor at Morningstar.

Yet the concept is catching on. Montgomery Asset Management plans to roll out a market-neutral fund later this year.

More-adventurous investors might consider contrarian funds, which use short selling to cushion against down markets. Heartland Small Cap Contrarian Fund, for example, buys stocks that it deems undervalued but puts a quarter of the portfolio into shorting the Standard & Poor's 500 index and 21 stocks.

"The S&P is overdone, overloved, and overvalued," says portfolio manager Bill Nasgovitz. The fund gained 2.6 percent in January, versus a 1.6 percent loss for its benchmark, the Russell 2000.