Long/Short Funds for the Long Haul

One of the top performers is Aberdeen Equity Long-Short(MLSAX Quote), which returned 7.70% annually over the past decade. With stocks falling during the first half of this year, the fund was ahead of the S&P by 10 percentage points. That showing isn't surprising for a fund that sells short. But Aberdeen also beat the S&P in 2007, a year when the market rose.

The fund has achieved its record by taking long positions in stocks that seem poised to surpass Wall Street's forecasts for earnings growth. Aberdeen goes short stocks that are likely to produce earnings disappointments.

In 2007, the fund took full advantage of its ability to go long and short. Portfolio manager Christopher Baggini scored by shorting banks and other financial stocks -- and he achieved gains by going long on a few financial names, including IntercontinentalExchange(ICE Quote), which handles red-hot commodity futures.

"We made money with financials that were not connected to the mortgage problems," says Baggini.

Another winning short seller is Schwab Hedged Equity(SWHIX Quote). The fund aims to outdo the S&P 500 a bit while taking less risk. To limit losses in downturns, the portfolio managers typically keep about 20% of assets in short positions.

That strategy has worked. During the past five years, the fund has returned 8.55% annually, about a percentage point ahead of the S&P.

The fund managers use Schwab's proprietary ranking system, which evaluates 3,000 stocks based on 19 factors, including valuations and free cash flow. The top 5% of stocks earn an A and are considered likely to outperform. The bottom 5% receive an F and are judged to likely underperform.