Long/Short Funds for the Long Haul

In 1995, long-short funds began an impressive streak. For 13 consecutive years, the group made money, according to Morningstar. No stock category came close to matching that record. Even such safe bond categories as intermediate government and intermediate municipal posted some losing periods.

During the late 1990s, the long-short funds attracted little notice. At a time when the S&P 500 was returning more than 20% annually, few investors cared about a vehicle that quietly delivered single-digit results. But in the difficult markets of this decade, the long-short funds began to stand out. In 2000, the funds returned 9.57%, 18 percentage points ahead of the S&P 500. The next year, the long-short portfolios returned 5.37%, outdoing the S&P by 17 points.

During the decade ending this June, the funds returned 3.51% annually, about half a percentage point ahead of the S&P.

As investors came to appreciate vehicles that could stay in the black, fund companies introduced new choices. The number of long-short funds has climbed from 12 in 2000 to 54 now.

To be sure, most of the new selections are not worth considering. Many charge high fees and deliver meager returns. But a handful rank as superior. These can serve as diversifiers, rising when stocks are heading down.

As their name suggests, long-short funds hold conventional stock portfolios -- known as long positions -- and also sell some stocks short, betting that prices will drop. In bull markets, the short positions drag down returns, but in downturns the funds surge ahead of the markets.