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- James Market Neutral (JAMNX). This fund employs a quantitative formula to select undervalued stocks for long positions and overvalued stocks to short. It holds roughly equal long and short positions.
- Laudus Rosenberg Value Long/Short Equity (BRMIX). It uses a quantitative formula to select roughly 600 mostly small-cap and midcap stocks to hold long and 400 stocks to short.
- Permanent Portfolio (PRPFX). This fund does not employ a long/short stock strategy. Instead, it permanently allocates its assets to 20% gold, 5% silver, 10% Swiss francs, 15% U.S. and foreign real-estate and natural-resource stocks, 15% U.S. aggressive-growth stocks, and 35% U.S. Treasury securities and cash. I don't have room to describe the rationale. Suffice to say, since its 1982 inception, the fund has recorded only three calendar-year losses: 13% in 1984, 4% in 1990 and 3% in 1994.
- Prudent Bear (BEARX). Despite the name, the fund is not a traditional bear fund that, in essence, shorts the major indexes. Instead, the fund attempts to produce positive returns in up or down markets. It relies on fundamental analysis to pick stocks as well as major indexes to hold long or short.
- Rock Canyon Top Flight (TOPFX). It uses a quantitative strategy for picking a concentrated portfolio of roughly 20 long and 20 short positions, mostly in small caps and midcaps. The fund's formula considers technical (charting) as well as fundamental factors.
- TFS Market Neutral (TFSMX). It uses a quantitative formula to identify small-cap long and short candidates. The fund allocates 60% of its assets to long positions and 40% to shorts.
Here's a table showing the minimum initial purchase requirement, the first full calendar year of operation, the Morningstar rating, and the one-year and three-year average annual returns for each fund as of April 10. I'll use some of this information to begin honing down the list.
| First full year | Morningstar rating (1 to 5) | 1-year return | 3-year return | Minimum initial purchase | |
|---|---|---|---|---|---|
1st Source Monogram (FMLSX) | 2004 | 4 | 3.7% | 7.9 | $1,000 |
Alpha Hedged Strategies (ALPHX) | 2003 | 3 | -0.6% | 4.9 | $10,000 |
Georgetowne Long/Short (GTWNX) | 2004 | 2 | -8.7% | 6.1 | $5,000 |
Hussman Strategic (HSGFX) | 2001 | 4 | 0.9% | 3.2 | $1,000 |
Icon Long/Short (IOLIX) | 2003 | 3 | -5.5% | 5.5 | $1,000 |
James Market Neutral (JAMNX) | 1999 | 2 | 4.1% | 1.7 | $2,000 |
Laudus Rosenberg Value (BRMIX) | 1998 | 1 | -2.1% | 0.9 | $100 |
Permanent Portfolio (PRPFX) | 1983 | 5 | 14.3% | 13.6 | $1,000 |
Prudent Bear (BEARX) | 1996 | Not rated | 12.2% | 8 | $2,000 |
Rock Canyon Top Flight (TOPFX) | 2003 | 4 | 12.7% | 6.3 | $5,000 |
TFS Market Neutral (TFSMX) | 2005 | 5 | 8% | 13.5 | $5,000 |
The Morningstar rating compares a fund's return-to-risk ratio with other funds in its category. The funds with the best ratios get five stars, and the worst get one star.
Morningstar ratings, by themselves, aren't sufficient to pick the best funds, but they are a good start. Few would argue that one- and two-star funds are obvious underperformers, so I ruled out James Market Neutral, Georgetowne Long/Short and Laudus Rosenberg Value. (The Prudent Bear fund is unrated because Morningstar doesn't rate funds in its bear category.)
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Simple rule: No losers
Next, since the point of picking market-neutral funds is to avoid losing money in up or down markets, I ruled out the funds that recorded losses over the past one or three years, specifically, Alpha Hedged Strategies and Icon Long/Short.The next table shows the best and worst calendar-year returns for the six surviving candidates. Because the funds have been in existence varying amounts of time, to be fair, I only counted years starting with 2003. Obviously, I could go back only to 2004 for 1st Source Monogram and to 2005 for TFS Market Neutral.
| 1st full year | Best year since 2003 | Worst year since 2003 | |
|---|---|---|---|
1st Source Monogram | 2004 | 14.7% (2006) | 3.8% (2005) |
Hussman Strategic | 2001 | 21.1% (2003) | 3.5% (2006) |
Permanent Portfolio | 1983 | 20.5% (2003) | 7.6% (2005) |
Prudent Bear | 1996 | 13.4% (2006) | -14.1% (2004) |
Rock Canyon Top Flight | 2003 | 52.8% (2003) | -4% (2006) |
TFS Market Neutral | 2005 | 24.2% (2006) | 5.9% (2005) |
Prudent Bear's and Rock Canyon's worst-year losses are not consistent with the strategy behind picking market-neutral funds, which is not to lose money. So, I eliminated both.
Down to 4
The last table lists the four remaining candidates along with two more factors worth considering: standard deviation and expense ratio.| Standard deviation | Expense ratio | |
|---|---|---|
1st Source Monogram | 6.3 | 1.6 |
Hussman Strategic | 3.4 | 1.1 |
Permanent Portfolio | 6.7 | 1.1 |
TFS Market Neutral | 8.3 | 2.5 |
Standard deviation sounds intimidating. But it's simply a measure of a fund's volatility, another word for risk, over time. So the higher the standard deviation, the riskier the fund. Generally, standard deviations below 10 define low risk. All of these funds would qualify by that measure. However, among these candidates, Hussman Strategic is the least volatile, and TFS Market Neutral is the most volatile.
Finally, the expense ratio is the percentage of a fund's assets taken out to pay operating expenses such as salaries, office rents, marketing costs and the like. Because a fund subtracts these expenses from its gross returns before you get your money, lower is generally better. However, keep in mind that the fund-return figures that we looked at earlier already had the expenses netted out.
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These four funds are all qualified market-neutral candidates, at least by my criteria. To get a better idea of how they compare, try plotting all four on the same price chart over varying time frames such as one, three and five years. Also, keep in mind that in a strong bull market, these market-neutral funds would likely underperform the major averages.
At the time of publication, Harry Domash held a position in the Hussman Strategic Fund.
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