August 5, 2008

Shortchanging the long-term

Long-short funds may be a nice addition to a healthy long-term investment strategy, according to Marta Norton of Morningstar. "Research has shown that adding hedge-fund-like investments to stock-and-bond portfolios has historically led to better risk-adjusted returns over the long haul," she says. But other kinds of assets, like real estate or commodities, work just as well for diversifying a portfolio, she warns. She outlines three major types of long-short funds:

Market neutral - These funds aim for zero broad market exposure, so their long and short positions are offset when the market moves a lot in one direction. They're riskier than the money-market or short-term bond funds they're sometimes compared to, so they don't make for good income replacement funds, according to Norton.

Absolute return - These funds use options or short selling to create a low-volatility, low-return profile. Norton says they work well in theory to smooth long-term volatility, but warns they also carry a lot of risk.

Equity variable - "Think opportunistic," Norton says. "The funds that fall in this subcategory often boast flexible mandates and can short stocks or load up on their favorites as they see fit."

Reprints Discuss this story
This is where the comments go.