Mutual funds are increasingly capitalizing on the popularity of hedge funds by availing themselves of some of the same investment tools used by their lightly regulated hedge fund cousins.

But while betting on declines in stock prices helped make some hedged mutual funds make money during the bear market, many of these same portfolios are trailing the market on the way back up.

The $762 million Calamos Market Neutral/A (CVSIX), for example, is a mutual fund that invests in convertible bonds — securities paying fixed returns but which can be converted into common stock at a set price. Rather than just hold the bonds in the expectation that their prices will rise, however, the fund hedges its bets by selling the stock short. That way, if convertible prices decline, it can offset the losses with money it makes on the short positions.

Closed to new investors since November 2001, the fund has produced annualized returns of 9.11% over the past five years, beating the Standard & Poor’s's 500-stock index by 10.60 percentage points. But it gained just 3.63% in the first half of 2003, compared with a 12.56% rise in the S&P 500, as the fund’s short investments have cut into gains for the year.

“If the markets continue to go up as they have, we’ll have to convince shareholders that 8% to 9% (for the year) is still a good return,” said John P. Calamos Sr., chairman and chief executive of Calamos Asset management and co-manager of the market neutral fund. For hedged mutual funds such as his, “the objective is to grind out an acceptable return” in all types of markets, he said.

Mutual funds have had access to many of the same tools long used by hedge funds since the Securities and Exchange Commission in 1997 loosened restrictions on short selling and allowed mutual funds to leverage the size of their investments by borrowing money. A short position is a bet on the decline in the price of a stock: the short seller borrows stock and then sells it in the hopes of buying it back to repay the loan at a lower price.

But mutual funds that use these hedging tools didn’t start to amass sizable assets from investors until the tech bubble burst at the end of the decade. Lake Partners, a Greenwich, Conn., investment firm, estimates that at the end of the second quarter there were about 50 mutual funds with combined assets of $8 billion that hedge against market declines on a regular basis, up more than sevenfold since the end of 1997.