An Alternative Approach

for example, returned 47% in 2007 and an additional 32% return in the first seven months of 2008.

 

Hedging your bets. Investing in such commodities funds and notes is fairly straightforward: if prices go up, you’ll make money. Hedge funds, on the other hand, are far from simple.

            The classic hedge fund goes “long and short.” That is, the manager buys assets that are expected to appreciate while borrowing assets expected to lose value. The borrowed assets are sold; the manager hopes to buy them in the future at a lower price, use those acquired assets to repay the loan, and thus make a profit on this “short sale.”

            Those types of hedge funds still exist but they’re not alone. Hedge Fund Research Inc., for example, lists 32 different strategies and sub-strategies of hedge funds, such as Event Driven: Merger Arbitrage and Macro: Systematic. The latter, according to HFR President Ken Heinz, are hedge funds that follow trends, using sophisticated quantitative modeling to buy what’s hot and sell short what’s not. Altogether, hedge fund assets have gone from less than $1 trillion at year-end 2004 to nearly $2 trillion in mid-2008, as investors search for ways to make money in challenging times.

            However, hedge funds might require investments of $500,000 or more, putting them out of the reach of many investors. A possible alternative is to choose a fund of hedge funds, where minimums are lower. “We’ve seen minimum investments as low as $50,000,” says Heinz. Funds of hedge funds offer diversification: Sudame says his firm offers clients a fund of 20 hedge funds, all following different strategies. They can be expensive, though, if you’re paying the fund-of-funds manager as well as the managers of the underlying hedge funds.

            A more practical option, for many people, is to invest in mutual funds using a hedging strategy. “We have been using Hussman Strategic Growth (HSGFX),” says Bill Brennan, founder of Capital Management Group in Washington, D.C. “It holds a portfolio of large-cap U.S. stocks while employing option strategies to earn income and protect against losses. During flat or down markets, this combination may produce superior performance.” As of this writing, this fund was up more than 4% for 2008 while the broad U.S. stock market had dropped nearly 13%.

            Both Sudame and Cordaro recommend TFS Market Neutral (TFSMX), another “long-short” fund. It has returned more than 13% a year for the past three years, far ahead