Hedge-fund techniques cushion mutual funds

Some mutual funds aim to give you most of the stock market's long-term gains without those wrenching drops.

Yes, there are some good ones that do exactly that. They use various hedging strategies to protect against market declines. After the past few tumultuous months, you probably don't need to hear too much more to give them a closer look.

Hussman Strategic Growth Fund (trading symbol HSGFX) operates something like a hedge fund. The manager, former University of Michigan finance professor John Hussman, uses stock-market futures and options to protect his portfolio against a market slump.

It has worked so far. The fund has shrugged off the recent crisis, rising slightly over the past year during a down market.

And, remarkably, it actually made big profits during the crash of 2000-2003. Overall, investors in this fund have doubled their money since it was launched in late 2000, with very little volatility. Wall Street averages during that time have barely risen.

Diamond Hill Long-Short Fund (DIAMX) also uses hedge-fund techniques. The managers buy shares they like, as in a regular mutual fund. But they also bet a smaller amount against shares they think are overvalued.

That should give the fund some cushion in a falling market, even though the bulk of the portfolio is still positioned for higher prices.

Its record is pretty good. The fund gained about 5.6 percent during the last year, according to Lipper. And over five years it has more than doubled investors' money. Diamond Hill lost money during the bear market of 2000 to 2003, but a lot less than most regular mutual funds.

Gateway Fund (GATEX), which has been around since the 1970s, uses a "covered call" strategy. It owns shares, and sells call options on the market. This strategy sacrifices some upside in return for income. Through most markets the fund generates good returns by profiting from those option sales.

Over 10 years Gateway has beaten Wall Street handily with a lot less volatility. Maximum losses during the bear market were 22 percent, compared to almost 50 percent for the market overall.

All three funds involve some trade-off. They will probably lag a simple index fund during a raging bull market. Nor are they likely to be totally immune from a complete meltdown either.

But they can make a good addition to a portfolio.

Most U.S. equity funds have actually lost ground in the last year. The decade is proving dismal for investors. And as the Japanese can attest, bear-market blues can last a long time.

And many investors have also just discovered that they weren't as "diversified" as their financial adviser said. When the subprime crisis hit, those European and emerging-markets mutual funds actually did worse than Wall Street. Globalization, after all, means the world is tied together more closely than before.

But if different asset classes might not diversify your portfolio, different strategies just might.