Best and Worst Long-Short Mutual Funds

PROFITING FROM FALLING stock prices, a.k.a. short-selling, sometimes gets tagged for being unseemly. But in today’s tough market, who has time for high-mindedness?

Perhaps this is why long-short mutual funds have grown assets nearly 20% this year, while most other fund types are experiencing outflows, according to Morningstar. Some $25 billion is invested in long-short funds today. As the name implies, long-short funds not only buy stocks for the long term (as other equity mutual funds do) but also short stocks, betting that their prices will fall. This blend of strategies, which is similar to how some hedge funds operate, ostensibly helps during uncertain times because profits can be had whether the broad market is rising or falling.

And year to date, the approach is looking respectable enough. Long-short funds are down an average 4% so far in 2008, compared to the S&P 500’s decline of 13%.

We asked Morningstar to help us find the best- and worst-performing long-short funds, based on five-year returns. We went with five-year records since this isn’t about timing the market but riding it out. After eliminating institutional share classes and funds requiring minimum investments above $5,000, the winner was Diamond Hill Long-Short (DIAMX), which has returned more than 12% annually over the past five years.

Be forewarned that Diamond Hill charges a sales load. But then, so do all but one fund that made our top five. Expense ratios can be high too. That's because the trading strategies employed by the funds tend to be complex and require more active management and portfolio turnover. Even some of the laggards may be worth a look. Calamos Market Neutral Income (CVSIX), for instance, is cheap compared with other long-short funds and has done well in bear markets.

Also See:
World's Best and Worst Developed Markets
Best and Worst Taxable Bond Index Funds
Best Money-Market Mutual Funds