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Market-Neutral Mutual Funds Fail To Deliver

Many sustained losses amid market turmoil last month, and three have done so poorly they were shut down.

When you invest in a "market-neutral," "long-short" or "absolute return" mutual fund, you hope it's going to insulate you from the worst of the stock market's storms. After all, unlike typical mutual funds, these funds can bet on share prices falling as well as rising. So they can make money in any kind of market, not just ones that rise.

So how did they do during this summer's stock market hurricane?

Try this: Three such funds run by Denver, Col.-based Geronimo Funds did so badly that last month that the company decided to shut them down.

(GCHPX)

Geronimo Multi-Strategy (GCHPX) plunged 9.36% through July and August, according to Lipper.

(GPSOX)

Geronimo Sector Opportunity (GPSOX) fell 3.57%, and

(GPOCX)

Geronimo Option and Income (GPOCX) fell 2.03%. All are down for the year.

Ouch. How's that for market neutral?

When I was a kid, "Geronimo!" was what you shouted before you dive-bombed the swimming pool from the top board.

A long drop, a loud splash, and everybody gets wet.

I guess Geronimo CEO David Prokupek, who also ran the funds, had the same idea. He founded the investment company out West just two years ago.

Maybe he can name his next funds after General Custer.

Geronimo could not be reached for comment.

Prokupek wasn't alone in having a rocky summer.

Investors in

(TFSMX)

TFS Capital Market Neutral (TFSMX) got a shock during the market rout in early August: Their investments proved far from neutral, losing a stunning 11.8% -- or almost one dollar in eight -- in just nine days.

The reason? Manager Rich Gates says the fund was a drive-by victim of the crisis at the big hedge funds such as those at

Goldman Sachs

(GS) - Get Goldman Sachs Group, Inc. (GS) Report

. "We owned a lot of the same securities that the big hedge funds owned," he explained, "and when they sold out their positions, it hurt our performance," he says.

No, he's not talking about the subprime mortgage paper that got the hedge funds into trouble. He's talking about all the other stuff they owned -- such as blue-chip U.S. equities -- that the funds had to sell to shore up their balance sheets.

TFS Market Neutral is a "quantitative" fund; its investment strategy is driven by a computer model. It sounds like it uses a similar model to the ones used at the big hedge funds.

Gates points out that the fund has been "climbing back up the mountain" since that week. Overall it ended August down 6.49%, after a milder 0.75% drop in July.

By coincidence, Friday was the fund's third anniversary. The fund is about level with the

S&P 500

over that time, with a lot less volatility, Gates says. (Whether or not the fund actually beat the S&P over the three years came down to Friday's performance data.)

The fund's performance figures are net of fees, and that makes them pretty impressive, as the fees are a hefty 2.5%.

Other long-short mutual funds have fared much better so far this summer.

Look at the

(COAGX) - Get Caldwell & Orkin Gator Capital L/S Report

Caldwell & Orkin Market Opportunity Fund (COAGX): Shares are up 13.6% since the start of July and 20.23% from the start of the year. The reason? Morningstar analyst Todd Trubey says the managers had been anticipating the credit crisis for some time and had positioned their fund appropriately.

The problem: The fund missed a lot of the earlier bull run for the same reason.

The fund has averaged just 3.86% a year over the past five years. The comparable figure for the S&P 500 is around 12%.

Another fund that coped well this summer was

TheStreet Recommends

(HSGFX) - Get Hussman Strategic Growth Fund Report

Hussman Strategic Growth (HSGFX). Trubey explains that manager John Hussman is a classic stock-picker, but then seeks to insure his portfolio against turbulence by going short -- placing down bets -- on the wider stock market indices.

Result? The fund has risen 3.72% since the start of July. It's up 5.12% since the start of the year.

Once again, hedging has its obvious costs and benefits. Overall, the fund has handily outperformed Wall Street since it was launched in 2000. But most of that comes from the fact that it boomed during the bear market of 2001 and 2002, when it gained better than 14% a year. It has lagged the market significantly during the boom of the last five years.

The market turmoil of the last three months, including Friday's selloff, has obviously reminded everyone that prices can go down as well as up.

And investors may be looking to diversify their own portfolio to include some funds that aren't simply tied to the fortunes of the S&P 500.

Trubey recommends Hussman and Caldwell & Orkin. He also likes

(DHFCX) - Get Diamond Hill Long-Short C Report

Diamond Hill Long-Short Equity (DHFCX). "It's one of our favorites," he says. Managers Chuck Bath and Ric Dillon "are very smart guys and are very disciplined." The caveat: The fund is not technically market neutral. The managers take short positions to make money, not simply to provide insurance.

Diamond Hill Long-Short Equity is up about half a percentage point since the start of July. It's not exciting, but that's the point. And over the longer term, the performance has been excellent. According to Lipper, it's actually beaten the market over the past five years, averaging 14.02%.

Going into the third quarter, Diamond Hill was heavily longenergy -- its biggest holdings were

Apache

(APA) - Get Apache Corporation Report

,

Devon

(DVN) - Get Devon Energy Corporation Report

and

ConocoPhillips

(COP) - Get ConocoPhillips Report

.

The fund was also short some very bignames, including

Amazon

(AMZN) - Get Amazon.com, Inc. Report

,

Apple

(AAPL) - Get Apple Inc. (AAPL) Report

,

General Motors

(GM) - Get General Motors Company (GM) Report

,

Ford

(F) - Get Ford Motor Company Report

and

Procter & Gamble

(PG) - Get Procter & Gamble Company Report

.

In keeping with TSC's editorial policy, Brett Arends doesn't own or short individual stocks. He also doesn't invest in hedge funds or other private investment partnerships. Arends takes a critical look inside mutual funds and the personal finance industry in a twice-weekly column that ranges from investment advice for the general reader to the industry's latest scoop. Prior to joining TheStreet.com in 2006, he worked for more than two years at the Boston Herald, where he revived the paper's well-known 'On State Street' finance column and was part of a team that won two SABEW awards in 2005. He had previously written for the Daily Telegraph and Daily Mail newspapers in London, the magazine Private Eye, and for Global Agenda, the official magazine of the World Economic Summit in Davos, Switzerland. Arends has also written a book on sports 'futures' betting.