I am looking for a fund that shorts specific stocks or balances long and short positions. My options with my 401(k) plan are limited to long positions. -- Phil Spain


Short-selling has always had a whiff of mystery, maybe even romance. It's redolent of insider knowledge, two-fisted trading and whisper campaigns.

Whatever the sex appeal, some of the new wave of funds that use shorting haven't been very successful. And the ones that have flourished are now closed.

In short-selling, an investor bets that a stock will go down by borrowing shares and then selling them with the hope that those shares can be bought back more cheaply when it's time to return them.

Shorting is not a traditional investment approach for a reason. With short-selling, an investor has fixed profits (a stock can only go to zero) but an unlimited downside because a stock can theoretically rise forever.

Until 1997, few mutual funds engaged in short-selling. But changes in the tax law that year eased restrictions on short-selling by mutual funds, giving way to a new crop of funds.

Short-loving funds can be divided into three loose categories: long-short funds, market-neutral portfolios and bear funds.

A long-short fund will obviously use both long and short positions but the two strategies are not meant to offset one another on a continuing basis. This is a strategy that relies on managers to find winning stocks to go long and fumbling ones to short, trying to gain on both sides.

"With what I'll call a long-short fund, you are looking for the manager to hit the ball out of the park like a hedge fund," says Geoff Bobroff, a mutual fund consultant. Basically, you are betting on the security selection of a manager.

Alas, the two funds that utilize these hedge fund-type strategies and have had the most success are now closed. The

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Caldwell & Orkin Market Opportunity fund, which opened in 1991, closed last year, and the


Montgomery Global Long-Short fund closed earlier this year. Both funds were able to produce fat returns and enough press attention that they were forced to shut off the flow of new money.

When it closed in August 1998, the Caldwell & Orkin fund was up 20.7% for the year while the S&P 500 was down 0.35% for the same period. But for 1999, the fund is up only 0.63%. The Montgomery Global Long-Short fund is up 40.2% this year through July 1, according to



The remaining field of long-short funds is thin, diverse and somewhat untested.


Undiscovered Managers Behavioral Long/Short

fund only opened at the beginning of the year. This fund, subadvised by

Fuller & Thaler Asset Management

in San Mateo, Calif., uses investment strategies that are based in behavioral finance, which is study of how security prices are affected by human behavior. The managers attempt to identify mispriced securities that result from behavioral biases of market participants.

The fund's long and short positions are based on independent strategies. For example, the manager tries to find overvalued securities to short by examining factors such as insider selling and declining fundamentals.

However, this fund's record so far is not impressive. It is down 3.3% for the year. Mark Hurley, president and chief executive of Undiscovered Managers, stresses that the fund is a long-term investment. You will have to buy the fund through an adviser or a selected broker-dealer unless you can meet the $250,000 investment minimum.

Another so-called long-short fund is


Warburg Pincus Long-Short Equity, which was launched last year. The fund, which carries a minimum initial investment of $25,000, is up 8.5%, compared with 13.1% for the

S&P 500

. That is not such a favorable comparison considering the fund's stated investment objective is to beat the S&P 500.

The fund has an unusual investment tack: It buys shares of the


Warburg Pincus Long-Short Market Neutral fund, as well as S&P 500 index futures, options on S&P 500 index futures and equity swap contracts to gain exposure to the equity market.

That brings me to another type of the fund where shorting shows up: the market-neutral fund.

When these funds started appearing in 1997 they were being touted as low-risk investments that are structured, like the name says, to neutralize the effect of the stock market's overall direction.

Warbug's market-neutral fund, for example, is composed of two portfolios of stocks, one of long positions and one of shorts, that are meant to eliminate the direction risk of the equity market, says the fund's manager Eric Remole. The basic return of the fund should be about a Treasury bill return plus the spread between the long and short portfolios.

But the returns for market-neutral funds have been less than expected, leading some to question whether the strategy even works. The Warburg Pincus Long-Short Market-Neutral fund is up only 0.6% this year. The

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Barr Rosenberg Market Neutral fund is down 11.1%. The


Phoenix-Euclid Market Neutral fund is off 6.2%.

Lastly, you can also find shorting techniques in bear funds, like

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Rydex Ursa. But bear-market funds are meant to perform well when the market is suffering. To use a bear fund effectively, you have to be able to call the direction of the market, an impossible task.

Many of these funds that use short-selling are awfully new and haven't had enough time to develop significant track records. With funds so young, you may also have a difficult time turning up details on them, except those you get from the company.

If you really want to add some downside protection, you may want to think about balancing your portfolio with cash or a bond fund. You should be able to find a money market or bond fund in your 401(k) even.

Portfolios Needed

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