Looking back at 2008, investors went through a lot of disappointment. Falling stocks in nearly every sector of the market left most investors with huge losses that wiped out years of previous gains.
The bear market made it just about impossible for stock investors to make any money last year. For instance, only a single stock mutual fund eked out even the tiniest of gains. But one investing strategy proved to be particuarly disappointing, despite beating out the overall market. Investors had expected this strategy to bring big rewards during tough times, but it too couldn't escape the bear unscathed.
Bucking the stock trend
Many people judge their investment success by comparing their performance against benchmarks. With a diversified portfolio of stocks, you can aim to outperform major market indexes in a given year. But with those indexes down 30%-40% in 2008, even beating the market by a wide margin still left you with huge losses. Typically, even the best professional fund managers have returns that are closely correlated to the broader market.
Investors seeking an alternative to traditional stock funds can invest in a different sort of mutual fund. Known by a variety of names, including long-short, market-neutral, and absolute-return funds, these alternative funds give investors the hope of earning solid returns in any market.
Missing their day in the sun
This month's issue of the Fool's Rule Your Retirement newsletter -- available online at 4 p.m. EST this afternoon -- discusses how these alternative funds can fit into an investor's portfolio. By offering returns that aren't connected to the performance of the stock market, these funds should theoretically be extremely valuable when it comes to helping investors avoid the big swings that most investments endure during volatile markets.
Unfortunately, the reality of many of these funds fell well short of investor expectations. Here are some of the largest funds in Morningstar's long-short category, which includes market-neutral and absolute-return funds:
|
Fund |
2008 Return |
3-Year Avg. |
|---|---|---|
|
Gateway Fund (GATEX) |
(13.9%) |
0.6% |
|
Hussman Strategic Growth (HSGFX) |
(9%) |
0.2% |
|
Diamond Hill Long-Short (DIAMX) |
(23.7%) |
(2.3%) |
|
Calamos Market Neutral (CVSIX) |
(13.3%) |
(0.3%) |
|
TFS Market Neutral (TFSMX) |
(7.3%) |
9.1% |
|
Absolute Strategies (ASFAX) |
(14%) |
(1.2%) |
Source: Morningstar. As of Jan. 7.
If you compare these 2008 results to a broad stock index like the S&P 500, the returns look fantastic. But if you expected positive returns uncorrelated with the market -- well, you weren't even close.
Unrealistic expectations
The problem, though, isn't with the funds themselves, but rather with the mistaken impression investors have of these funds. Just because a fund's returns are uncorrelated with the market doesn't mean that they'll never go down.
For instance, Gateway has a portfolio that includes many of the largest U.S. companies, including ExxonMobil (NYSE:XOM), AT&T (NYSE:T), and Bank of America (NYSE:BAC). But it also sells call options and buys put options to help dampen volatility. So it won't entirely avoid losses in bear markets -- but investors won't feel the full brunt of them.
In other cases, poor stock picking can hurt results. The Diamond Hill fund, for example, shorted Laboratory Corp. (NYSE:LH), which didn't lose as much as the overall market. Meanwhile, despite a good long pick in General Mills (NYSE:GIS), losses from UnitedHealth Group (NYSE:UNH) and Microsoft (NASDAQ:MSFT) hurt the fund's results.
Where alternative funds fit in your portfolio
So what's the right way to use these funds? As Fool expert Robert Brokamp explains in this month's newsletter, the key is looking at a fund's long-term results and knowing what to expect. In his article, he looks at more than a dozen intriguing alternative funds -- including two of those mentioned above -- that could help you improve your investing performance.
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For more on investing for a healthy retirement:
- The smart retirement move you should make today.
- One way never to run out of money.
- How you can avoid a gruesome retirement.
