Five Sane Alternatives to Hedge Funds

On the one hand, mutual fund investors are being spooked by market volatility. On the other, those seeking refuge in money-market funds are most likely not even keeping up with inflation, thanks to the Fed's recent interest-rate cuts.

The good news is that a possible middle ground exists.

"Market neutral" open-end funds offer hopes of CPI-beating returns with the possibilities of avoiding some of the unsettling vicissitudes of the stock market. These are essentially Everyman's answer to hedge funds.

Hedge funds' high initial investment levels and lofty minimum net-worth thresholds place them outside the reach of most retail investors. But the open-end market neutral instruments, like the more traditional hedge funds, combine long and short ownership positions in attempts to add value, regardless of the general direction of the stock market.

Of roughly 40 such funds tracked by TheStreet.com Ratings, the five with grades in the "A" and "B" ranges -- which equate with "buy" recommendations -- are listed in the accompanying table.

The Diamond Hill Long-Short FundDIAMX and the TFS Market Neutral FundTFSMX produced positive returns for their holders over the difficult past three calendar months. The remaining three slipped lower, but experienced declines significantly less severe than the S&P 500 total-return index.

All five funds on the list posted positive results over the past 12 months, easily beating the S&P, which skidded 3.60% during the period.

The annualized returns of four of the "hedge fund alternatives" surpassed that of the S&P over the past three years. The Diamond Hill Long-Short Fund and the TSF Market Neutral Fund achieved double-digit returns for the period. Only the JPMorgan Market Neutral FundJMNAX was fractionally lower than the S&P.

As measured by their standard deviations, a statistical gauge of volatility, each of the five subjected shareholders to less volatility than the S&P over the past year. The Diamond Hill Long-Short Fund and the JPMorgan were especially effective in avoiding the many jolts experienced by the market over the past 12 months. Standard deviation is a measure of the annualized rate at which a fund's monthly returns tend to vary from trend over a period.

Buy-Recommended Market Neutral Open-End Mutual Funds
NAME, TICKER & TheStreet.com RATINGS GRADE	3-Mo. Total Ret'n (%)	12-Mo. Total Ret'n (%)	3-Yr. Ann'l Ret'n (%)	12-Mo. Std. Deviation (%)	Ann'l Expense Ratio (%)
1st Source Monogram Long/Short (FMLSX) A *	-1.70	3.05	6.52	7.81	1.84
Alpha Hedged Strategies NL (ALPHX) B+ *	-3.82	2.04	5.42	6.85	3.99
Diamond Hill Long-Short Fd Cl A (DIAMX) A+	1.59	6.67	11.26	5.13	1.50
JPMorgan Market Neutral Fund A (JMNAX) B+	-0.96	6.26	5.02	3.45	1.51
TFS Market Neutral Fund (TFSMX) A+ *	0.63	9.43	12.82	11.06	2.50
S&P 500 Composite Total Return	-9.68	-3.60	5.37	11.56
* No-load fund. Source: TheStreet.com Ratings. Data as of 2/29/2008.