Earlier this month, Standard & Poor’s reported that five of 2002′s top performing mutual funds are profiting from short selling strategies.

The average total return for the funds AXA Rosenberg: Value Market Neutral/Inv (BRMIX); James Advantage Market Neutral Fund/A (JAMNX); Phoenix-Euclid: Market Neutral/B (EMNBX); Potomac US/Short/Investor (PSPSX); and Prudent Bear Fund (BEARX) through July 26, 2002 was 28.7%, compared with the average domestic fund’s return of -12.07%.

All five funds have also increased their S&P star ranking by an average of 2.5 stars in the last three months because of their heavy emphasis on shorting stocks.

“The ability to produce positive returns in these market conditions is attracting assets to hedge funds and stimulating the creation of retail versions of what was once only available to the very wealthy or institutions,” notes Standard & Poor’s Managing Director of Global Fund Research Phil Edwards in a company press release. “Investing in hedge funds is a long-term strategy that many employ to provide diversity to their portfolios, since hedge funds are typically uncorrelated with the equity market,” continues Edwards. “They can be an effective long term-strategy if employed wisely.”

Schwab is one company that has entered this fray. It recently introduced the Schwab Hedged Equity Fund, see Coming Up Shortly in IA’s September issue.

Despite the success of these funds, S&P warns investors of the risk correlated with short selling practices. “Any type of fund that employs short strategies is considerably riskier than the more traditional long-only strategy,” warns Standard & Poor’s Edwards. “Investors should be aware of the risks before simply diving in to chase the positive return stream.”

Staff Editor Megan L. Fowler can be reached at mfowler@ia-mag.com.