Hedge Your Bets With This Long-Short Fund

The decision to close a position usually comes from a change in the drivers of a stock (this could be after a stock works out well or does not work out well) or if they realize they have made a mistake. The willingness to recognize mistakes, like a short on Research In Motion (RIMM) from earlier this year, tells me they are more concerned with the result they deliver than their egos.

This fund's fees, which are capped at 1.99% through 2008, may be contentious for some. This rate may seem high, but it is very much in the ballpark for other long-short funds. This investment category tends to be more expensive because selling short incurs expenses that long does not. Over time, as the fund gets bigger, the managers believe they will be able to lower the fee.

Fedenia and Schroeder believe that track record matters. They note that even though this fund is very new, they have executed this strategy for several years in the hedge-fund world. To be clear, the accompanying chart does not show the performance of the mutual fund, but the same crew with the same strategy in a hedge fund.

Integrating a fund like this into a diversified equity portfolio should reduce volatility and increase risk-adjusted return. This is an important concept if the market is going to be more volatile for the time being, especially if we are late in the stock-market cycle.

Another idea we discussed was using an absolute-return fund like Nakoma as a bond substitute. Fedenia and Schroeder believe that, over the next couple of years, interest rates could go higher. This makes sense to me for a couple of reasons; a weaker dollar puts pressure on the Fed to raise rates to make U.S. assets more attractive overseas, and the yield curve is likely to steepen as this economic cycle slows.

And it's generally not a good idea to hold bonds when interest rates are rising. The yield and the price of bonds have an inverse relationship. If rates are going up then prices are going down. Bonds with longer maturities are generally more sensitive to this relationship.

If that scenario makes sense to you, then an investment with the attributes of the Nakoma fund could very well serve as a proxy for part of your bond portfolio, volatility-wise, although it won't replace the yield.

My own take is that the ability to capture most of the market's return over the long term with far less volatility should appeal to a lot of people. Investors who save a lot relative to their needs can take less risk in their portfolio and still reach their financial goals.

Smoothing the Market's Bumps Nakoma Absolute Return Fund's managers have a strong track record with the same strategy at a hedge fund.

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Off to a Strong Start Nakoma Absolute Return Fund's performance since inception.

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