The current environment may be the best kind for investing in hedge funds.
Investors trying to position their portfolios to maximize return and minimize risk are challenged in the current environment to balance two primary risks: 1) principal risk, or more specifically the risk of declining account values during a bear market, and 2) the risk of missing out on gains in the event of a strong final leg up in the bull market.
Hedge funds generally invest in a diverse mix of negatively correlated assets for the purpose of minimizing volatility and for achieving long-term absolute returns that can outpace inflation. Therefore, in an up market, hedge funds tend to have modest, single digit returns that are often below broad stock market indices. But in a down market, the best hedge funds will have near-zero to positive returns.
So investors looking to capture at least some of the upside potential remaining in the current bull, but want to keep losses low to near-zero in an expected bear market, hedge funds can be a wise decision.
But how many of us investors have the high asset minimums to buy into hedge funds?
Look no further than these hedge-like mutual funds.
Best Mutual Funds: Hussman Strategic Total Return (HSTRX)
If you are looking for a mutual fund that can capture the upside of the last leg in a bull market, while maintaining positive returns in a bear market, Hussman Strategic Total Return (HSTRX) may be your choice.
The fund manager, John Hussman, is known for predicting the 2008-2009 recession and his weekly Hussman Funds market commentary is widely read by investors, money managers, and financial media pundits.
For historic evidence of hedge-fund-like performance, look no further than Hussman’s 6.3% return for 2008, during the worst of the most recent bear market decline, when the S&P 500 Index had a -37% return. That’s more than a 43% differential. Better yet, Hussman was able to capture a respectable 12.6% return, compared to 5.5% on the S&P 500, in the 2007 final leg of the preceding bull market.
Although Hussman may be more a tactical asset allocator than a hedge fund manager, his recent 60% allocation to cash makes HSTRX prepared for a decline in stocks, bonds or both. Top stock holdings include miners like Newmont Mining Corp (NEM) and utilities like PG&E (PCG).
You can buy shares of Hussman Strategic Total Return with an initial investment of just $1,000. Expense for HSTRX run 0.63%, or $63 annually for every $10,000 invested.
Best Mutual Funds: TFS Market Neutral Fund (TFSMX)
Mutual funds are more tightly regulated than hedge funds and therefore many hedge-like mutual funds use what is called a market neutral strategy. These funds attempt to reduce systematic risk with a combination of long and short positions.
Among the best, most accessible market neutral funds is TFS Market Neutral (TFSMX). If you are interested in a longer holding period or in making a hedge-like fund a core holding in your portfolio, you’ll be attracted to the 10-year annualized return of 6.5%, which ranks in the top 1% of all market neutral mutual funds.
TFS Market Neutral had a -7.3% return in the 2008 bloodbath for stocks, when the S&P 500 had a -37% return. Bookending that tough year, TFSMX had an impressive 11.5% gain in 2007 and 16.6% in 2009. Year-to-date 2014, the fund has a modest 0.9% gain.
The initial purchase minimum for TFS Market Neutral is $5,000. And because the fund involves a high number of short positions, the expenses run extremely high compared to the broader world of mutual funds. Total operating expenses for TFSMX run 8.13%.
Best Mutual Funds: Waddell & Reed InvestEd Conservative Fund (WICAX)
If you don’t have the stomach for contrarian styles of most hedge-like mutual funds you might be interested in a lighter, more conservative version in Waddell & Reed InvestEd Conservative Fund (WICAX).
The fund’s success in its play-not-to-lose strategy serves investors well in bear markets, which helped WICAX land on my recent story , Mutual Funds With 10 Years of Positive Returns.
Yes, you read that correctly: WICAX has not had one single calendar year of returns less than zero in more than a decade.
While the majority of calendar years since 2004 finds InvestEd Conservative in the bottom half of category peer performance rankings, the one year that mattered most, 2008, finds the fund in the top 2% with a positive return of 1.6%. By now, you’ve memorized that the S&P 500 had a -37% return that year.
If you’re curious about its current portfolio, WICAX was recently allocated at approximately 38% stocks, 32% bonds and 30% cash, with the underlying holdings being Waddell & Reed mutual funds. However, its tactical style is sure to make for varying allocations, depending upon market and economic conditions.
WICAX charges 0.95% in fees and a maximum sales charge of 4.25%, but it does have a very low initial purchase minimum of $750.
As of this writing, Kent Thune did not hold a position in any of the aforementioned securities. Under no circumstances does this information represent a recommendation to buy or sell securities.