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Few Funds Shine by Selling Short

NEW YORK ( TheStreet) -- Seeking protection from rough markets, investors have been pouring into long-short mutual funds. According to Morningstar, inflows have totaled $5 billion in the past year. That's a big figure for a category with $25 billion in assets.

The long-short funds aim to be less volatile than normal equity funds. To accomplish the goal, managers hold stocks and typically put 20% to 50% of assets in short positions. The shorts represent bets that stocks will sink.

Most of the long-short managers have produced uninspiring results. Despite the short positions, the category lost 15.4% in the turmoil of 2008. During the past five years, the funds finished a bit in the red, while the S&P 500 returned 1.2% annually.

What's holding back the long-short funds? For starters, they are expensive, says Jeremy Radcliffe, managing director of Salient Partners, a wealth adviser in Houston. The average long-short fund charges an annual expense ratio of 2.0%. That's cheaper than a hedge fund, but double what many mutual funds charge.

In addition, it is difficult to pick profitable short positions. The portfolio managers typically try to increase the short positions when markets look hazardous. They aim to reduce shorts when stocks are rallying.

But all too often, managers get it wrong, says Radcliffe. They take big short positions near market troughs when it is too late to avoid losses. Then the shorts drag down results as stocks rebound.

"Most of the managers are not really adding any value," says Radcliffe. "You could get better returns by putting 50% of your assets in the S&P 500 and 50% in cash."

But a few long-short managers have delivered solid results, limiting losses in 2008 and recording solid long-term returns. Among the top choices is MainStay Marketfield (MFADX), which returned 8.5% annually during the past five years, outdoing 95% of peers. Portfolio manager Michael Aronstein studies economic trends and makes bold sector bets. Most often he has been on target.

Worried about mounting housing problems in 2007, he shorted Goldman Sachs (GS) and other financial stocks. That protected shareholders during the downturn. Then in 2009, Aronstein bought airlines and other cyclical stocks that came roaring back in the rally.
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