Mutual funds that employ hedging strategies, such as those that sell stocks short or that buy and sell options, can smooth returns when the market behaves erratically.

Last spring, we wrote about four such funds (see Protection for Stormy Markets), which we thought would keep their cool if volatility were to heat up. The market's wild gyrations the past five months have been a major stress-test for the funds' hedging strategies.

Since we went to press with our article last April, two funds have excelled and two have delivered lackluster, though not horrific, results.

The steadiest showing came from Hussman Strategic Growth. Manager John Hussman's approach defines flexibility. Depending on his views of the market, he alternately uses options and short-selling to hedge against losses and employs leverage to enhance gains.

In commentary published on the Hussman Web site on July 16, he declared the stock market to be overvalued and said he had fully hedged his fund's stock holdings against the possibility of a market downturn. "Based on prevailing market conditions, we have no evidence on which to accept market risk here," he wrote.

Just three days later, the market began a decline that lasted through August 15. During that period, Standard & Poor's 500-stock index lost 9.0%. Strategic Growth, on the other hand, gained 2.5% -- our sole pick to stay in the black.

Hussman remains bearish and is keeping his fund positioned defensively. Over the past year through December 7, Strategic Growth (symbol HSGFX) has lagged the S&P 500's 9.0% gain by five percentage points, but it has done so with less than half the volatility. Returns have been flat since the market's autumn peak, reached on October 9. Since then, the S&P 500 has lost 3%.

The Gateway fund's performance has been impressive. Gateway sells call options on the S&P 500 to earn extra income and bolster returns. The price of call options rises in tandem with market volatility, so the amount of income the fund can generate with this approach has climbed steadily over the past year.

"We're trying to take advantage of that volatility as it comes," says co-manager Paul Stewart. The fund also buys puts -- or options to sell stocks at set prices over set date ranges -- to insure against dramatic short-term drops.

The approach has held up marvelously. Gateway's returns have also been flat since the market's peak on October 9, and the fund contained losses over the July-August drop to less than 4%. Over the past year, the fund (GATEX) has managed to match the index's 9% gain, but with only a fraction of the volatility. Gentlemen, hats off.

Long-short funds combine ordinary stock positions with short-sales, both to make money off individual stock declines and to hedge their exposure to market bumps. Schwab Hedged Equity runs computer models to choose a portfolio of stocks to own and another to short, with an aim of replicating the S&P 500's total returns with less volatility.

Although the fund has mitigated volatility over the past year, it hasn't done so well on the return end. Since we recommended it, Hedged Equity has eked out a 1% gain, while the S&P 500 has returned 7%. Since the market's peak on October 9, the fund (SWHIX) has performed the worst of our picks, losing 1.7%. Moreover, it matched the S&P 500's 9% loss from July 19 to August 15.

The performance of Laudus Rosenberg Value Long/Short Equity is tougher to gauge. Manager William Ricks strives to deliver returns independent of market movements by holding short positions equal to the value of the fund's long holdings.

The fund, which modestly measures itself against the risk-free 90-day Treasury bill, has actually lost a small amount of money since we recommended it. During the July-August period, it lost 3%, trailing the 90-day T-bill's 1% return. Historically, the fund (BRMIX) has outperformed in down markets-it gained 65% in the 2000-02 bear market, during which the S&P 500 lost 47%. In that light, the fund's 2.5% gain since October 9 is somewhat reassuring.

READER COMMENTS

Post a comment

Hide comment form

 | 

Read all comments (5)

Read recent comments

---

Permission to post your comment is assumed when you submit it. The name you provide will be used to identify your post, and NOT your e-mail address. We reserve the right to excerpt or edit for clarity any posted comments.
View our full privacy policy

Name:

E-mail:

Comment:

POSTED BY: Jack (December 22, 2007 08:59 AM)
Hussman seems to have lost his touch...Long term chart looks good, but the past year has been a disaster.

POSTED BY: HSGFX Holder (January 05, 2008 10:03 PM)
Jack - Calling Hussman's performance "a disaster" is doing him a grave disservice and looking past what he manages for - a full market cycle. You have to look at the performance of HSGFX from the peak of a bull market to the next peak, or from the trough a bear market to the next. Unfortunately that's hard to do in real time. Read his weekly pieces on his website and you may start to get the flavor. I'll admit it was frustrating at points in 2007 to watch the market climb while my HSGFX didnt budge, but it sure was gratifying to see it as the only greenbean in a sea of red on some of those nasty days in July, August and November.

POSTED BY: Dan Shirley (January 12, 2008 03:40 PM)
A lot of people, reviewing the fund's performance during the bear market of 2001/2003 have come to expect Hussman Strategic Growth to behave like a short fund and have been disappointed to see the fund remain flat in both up and down markets since the fund went fully hedged. There are many bear funds available but HSGFX is not one of them. This fund is mant to invest in growth when valuation is favorable and be hedged against a downturn. This it does.

POSTED BY: dan (January 16, 2008 11:12 PM)
and yet for the last, oh, 4 years, you'd have had better returns buying t-bills, no?

POSTED BY: josh (January 19, 2008 02:08 PM)
More than 12% annualized since the fund's inception in the middle of 2000 appears to be a bit better than t-bills. No one does well in every time period, so save yourself some frustration and view things as a long-term investor. More than twice the market's return, enough said.

EMAIL ARTICLE | PRINT | REPRINT ARTICLE | SUBSCRIBE TO KIPLINGER MAGAZINE |

FIND THIS ARTICLE HELPFUL?

SIGN UP FOR DELIVERY OF COLUMNS AND SITE UPDATES