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Alternative Funds That Stand Out From the Pack

NEW YORK ( TheStreet) -- Last year investors had little reason to applaud the performance of hedge funds or alternative mutual funds. During 2011, the Morningstar MSCI Composite Hedge Fund Index dropped 2.7%, a bad showing in a year when the S&P 500 gained 2.1%. Alternative mutual funds, which use strategies employed by hedge funds, also declined. Morningstar's long/short category lost 2.8%, while market-neutral funds lost 0.3%.

The results were especially disappointing because hedge funds sell short and use other techniques that are designed to excel in the kind of difficult markets that prevailed last year. Hedge fund managers offered a variety of explanations for the poor showing. Weak markets in Europe and the emerging markets hurt funds that invest abroad. Managers in the U.S. and overseas had trouble distinguishing themselves because stocks of all kinds rose and fell together. In addition, commodities funds suffered because markets were choppy and indecisive. That made it hard for traders who do best when trends move in clear directions.

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While the markets undoubtedly were difficult, some alternative mutual funds rose above the crowd and delivered decent returns in 2011. Among the best performers were American Century Equity Market Neutral (ALIAX), Gateway (GATEX) and Marketfield (MFLDX).

Can the top funds continue their competitive showing? Probably. In recent years, the best funds have achieved their goals, diversifying portfolios in downturns while delivering positive results in good times. But investors should not expect miracles. The top funds typically deliver single-digit long-term returns. In other words, the alternative funds will not make you rich -- but they could help you to avoid becoming poor.


A steady performer is Gateway, a long-short fund that returned 3% in 2011. Gateway returned 4.9% annually during the last 15 years, outdoing 66% of competitors. Over that period, Gateway lagged the S&P 500 by a bit, but the fund's real achievement was that it provided significant diversification. A low-volatility portfolio, the long-short fund excels in bear markets. In the downturn of 2002, Gateway outdid the S&P 500 by 17 percentage points. During the collapse of 2008, the fund surpassed the benchmark by 23 percentage points.
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