During the stock market s recent swoon, J.J. Burns has been getting the same message from his clients. Keep me out of the stock market, they tell the New York based adviser. But they also have another request: Make me money in the market if it soars.

So Burns, who manages more than $300 million for clients, says he s become a quick study on so-called alternative-investment mutual funds, products that seem to use every strategy invented except the one most of his clients are used to: buying and holding stocks. He s attended seminars, read fund literature and even called pals who went to the Massachusetts Institute of Technology to help him figure them out. And slowly, he s warming up to this newfangled form of investing. They can be a way to stay in the stock market, safely, he says.

After a long summer of watching some scary ebbs and flows in the market, a growing number of Main Street investors are dabbling in alternative investments that often take complex routes to achieve a simple goal: smooth out the big dips in their portfolio and end up with steady, long-term gains. Alternatives, which can involve anything from investing in commodities to betting on mergers and acquisitions, are still just a sliver of the $12 trillion mutual fund universe. But one of the most common forms, known as absolute-return funds, has almost tripled in size in two years, to $16.9 billion, taking in $6.7 billion in just the first six months of this year. Advisers say they can t get enough of them. We are not trying to kick the ball out of the park but rather get more predictable returns, says Jane Williams, who s finding herself recommending more alternative investments to her clients as chief executive of Sand Hill Global Advisors, a Palo Alto, Calif., wealth-management firm overseeing $1 billion.

To be sure, the woes of the Dow are spurring a lot of this action. But the money-management industry has been drumming up a lot of the interest too. Hedge funds, commodity pools and the like have been open to the well-heeled for decades. But by lowering the minimum investment on these products from the million-dollar range to as low as $1,000, fund firms are now aiming squarely at the broader market. They also have been adding new products for ordinary investors, launching more than 90 mutual funds that can be classified as alternative in the past three years alone, according to Lipper, a fund-research firm.

Some planners say that hot as it is, this is a trend investors can ignore. Funds that put their money in alternative investments can be expensive, with fees that are about twice as high as those of a traditional mutual fund. And while some of these products are marketed as all-weather investments, advisers question whether they can really make money in every investment climate. Larry Swedroe, director of research at the Buckingham Family of Financial Services, tells clients that adding high-quality bonds to a portfolio is a far simpler and cheaper way to hedge against a declining stock market.

Still, a growing number of planners are giving the new products a shot, with some putting as much as 30 percent of their clients portfolios in these investments. We assess the alternatives.

Illustration by Mark Ulriksen.

Managed-Futures Funds

MANAGED-FUTURES FUNDS

For years the conventional wisdom was that all but the very rich should stay away from futures, those dicey bets on the price of commodities and financial products from aluminum to Japanese yen. And while some advisers say these products are still too risky for their taste, others are starting to plunge in as funds open their doors to smaller investors: Assets in managed-futures mutual funds have more than tripled in the past two years, to $2.5 billion.

The basic idea behind these funds is to go with the flow: Managers often take their signals from math formulas and charts, buying futures as prices rise and selling as they fall. Things in motion continue to stay in motion, says David Kabiller, cofounder of hedge fund firm AQR, which recently introduced a Managed Futures Strategy fund for smaller investors. They don t always go in the same direction, of course: During market extremes, like 2008, managed futures typically outperform. But when the market is treading water or reversing course, the strategy often lags behind stocks. In 2009 the BarclayHedge CTA index, which tracks these strategies, was essentially flat, while stocks soared.

Evaluating these funds can be tricky, since managed futures in the mutual fund arena have short track records. The funds can also be costly, with annual fees as high as $300 or more for every $10,000 invested. Legend Financial adviser Louis Stanasolovich says it s crucial to scrutinize the fund material to understand the underlying strategy and risks. They are excellent diversifiers, but you have to stick with them, says Stanasolovich.

Our Picks

Assets: $340 million
Expenses: $150 per $10,000 invested
Launched this year by a hedge fund company with a successful track record, this fund uses computer models to spot trends in 104 different investments, including Japanese bonds, currencies, aluminum and corn.

Assets: $2.2 billion
Expenses: $210 per $10,000 invested, plus a 4.75 percent sales charge The three-year-old fund follows trends in 24 different types of futures contracts, with a large chunk in commodities.

Long-Short Funds

LONG-SHORT FUNDS

During the crash of 2008, many investors watched in horror as their stock funds tanked and kept tanking. For some, that raised a question: Why not invest in a fund that can swing both ways? Buy stocks when things are going well, and short, or bet against them, when the outlook isn t so hot.

Long-short, a strategy that s often associated with hedge funds, essentially describes any fund that can bet both for and against the stock, bond or commodity markets. Some funds use borrowed money to try to juice returns. Others aim to lower risk by taking short positions to offset other parts of a portfolio. The strategy involves more risk than some other alternative investments. But that hasn t stopped investors from adding nearly $1.3 billion to long-short funds in the first half of the year alone, bringing total assets in the group to $6.2 billion.

Despite their popularity, performance is all over the map. In 2009, when the broader market soared, the best long-short fund gained 82 percent while the worst lost 15 percent, according to Lipper. That s why many advisers say it s best to stick with funds that do relatively well in both a market crash and a recovery. And even then, it s crucial to pick managers who communicate with investors clearly and often since the fund s holdings can change quickly, says Peter Cowenhoven, director of investments at Delessert Financial Services.

Our Picks

Assets: $6.6 billion
Expenses: $109 per $10,000 invested
Manager John Hussman, a former finance professor, evaluates price trends, volume and valuation to gauge the attractiveness of stocks and uses index options to hedge the portfolio.

Assets: $384 million
Expenses: $103 per $10,000 invested
The fund s 9 percent average annual return over the past 15 years puts it at the top of Morningstar s long-short category. The fund can go to extremes, at times committing 100 percent to the stock market and, at others, betting completely against it.

Market-Neutral Funds

MARKET-NEUTRAL FUNDS

Sometimes, boring can be good. Or at least Alfred Winslow Jones, a journalist turned investor, seemed to think so when he opened a hedge fund in 1949 with the idea of minimizing the overall risk of stock investing while still owning stocks. Today market-neutral funds invest in a similar manner, making them one of the more ho-hum strategies used by hedge funds. When they work well, market-neutral funds can provide stocklike returns but with the lower risk associated with bonds, says Tyler Scott, a senior portfolio manager at Sand Hill Global Advisors.

Market-neutral managers essentially try to cancel out some of the forces driving the market, using complex automatic trading programs to capture the moves related to the prospects of a particular company. Managers buy some stocks and bet against others, sometimes using convertible bonds and options. Arbitrage funds, a subcategory of market-neutral funds, try to capitalize on price changes after mergers are announced, typically buying the stock of the takeover target and selling the stock of the acquiring firm. The strategy can backfire if a deal blows up, but Kabiller, of AQR, says that the vast majority of deals have actually gone through.

Despite their growing popularity market-neutral funds have seen their assets balloon to $32.5 billion from $17.8 billion over the past two years experts say individual investors should tread carefully. Individual fund performance varies wildly, with the best market-neutral fund up 23 percent last year and the worst down 18 percent. Overall, the funds did their job of smoothing out the market s wild swings. On average, equity market-neutral funds fell only 7 percent in the crisis of 2008 and gained just 5 percent in last year s big rebound, according to Lipper.

Our Picks

Assets: $1.3 billion
Expenses: $152 per $10,000 invested, plus a 5.25 percent sales charge
The fund uses J.P. Morgan s own stock analysts plus computer models to find the best investment ideas in both stocks and currencies.

Assets: $1.6 billion
Expenses: $195 per $10,000 invested
Seeks to profit from corporate takeovers, and tries to limit its risks by avoiding deals that could be scuttled by regulatory or financing issues.

Multistrategy Funds

MULTISTRATEGY FUNDS

When it comes to alternative strategies, the new kids on the block try a little of everything: Multistrategy funds use stocks, bonds, options, commodities and virtually any other asset to try to make money. It s the kitchen sink approach, says Lipper research manager Jeff Tjornehoj.

That doesn t mean the approaches are all the same, of course. Natixis ASG Global Alternatives, run by MIT s Andrew Lo, tries to replicate the best of hedge funds for smaller investors. It s a lot like an index fund, investing in some of the same stocks, bonds and commodities that hedge funds are investing in. For example, Lo s analysis found that by mid-2009, hedge funds were taking on more risk. So he boosted his fund s own exposure to riskier assets like global stocks and commodities and lightened up on government bonds by buying and selling futures contracts on these markets. At the same time, Lo tries to cut down on risk by moving money away from areas where volatility is increasing. It is basically a way to get broad-based plain-vanilla exposure to alternatives, he says.

Others try the team approach: The Turner Spectrum fund sticks mostly with stocks but uses six different strategies run by six separate managers. Absolute Strategies turns to 12 subadvisers, who invest in everything from out-of-favor stocks to distressed debt. The diversity of both managers and strategies results in lower overall risk.

While advisers see promise in some of these one-stop alternatives, their track records are short, and even the funds run by former hedge fund managers using similar strategies have yet to be tested as mutual funds. The ones that flourish, however, could eventually command much more than the tiny slice of portfolios that alternatives are still relegated to today. Some planners say the right multistrategy fund could even take the place of ordinary stock and bond funds. If you can be flexible and quick to make moves, you can do well in any market, says Mike Bowen, senior financial adviser at WealthTrust in Scottsdale, Ariz.

Our Pick

Assets: $430 million
Expenses: $161 per $10,000 invested, plus a 5.75 percent sales charge
Using computer models and statistics to mimic the portfolios of hedge funds, the fund beat Morningstar s hedge fund index in its first year.

Mapping Alternative Routes

Shopping for the right alternative investment for your portfolio is a little trickier than just picking a stock fund. Here s what to watch out for.

Experience Counts:
As the mutual fund industry rolls out new alternative products, some advisers recommend sticking with funds that have applied these strategies through several market cycles. A study in the Journal of Quantitative Financial Analysis found alternative mutual funds run by former hedge fund managers beat their peers by an average of four percentage points a year.

Hedge Your Hedge:
Some alternative strategies will do better than others in different types of markets. To spread the risk, investors may want to diversify their alternatives, says Cindy Zarker, director of research at market-research firm Cerulli Associates.

Keep It Liquid:
Unless you have a strong stomach and plenty of time, steer clear of alternatives that invest in products that are difficult to trade, says New York financial adviser J.J. Burns. Potentially illiquid investments, such as equipment leases and private real estate investment trusts, could get battered in a panic or caught short if a trend reverses.

Look Beyond the Name:
Some funds that describe themselves as long-short funds don t always live up to their billing. They basically buy stocks the long part of their name but they don t always sell them short. That means investors could miss out on the part of the strategy that calls for hedging against a decline in the market or individual stocks.