Part Of The Reason I've Always Hated Mutual Funds

Market-Neutral Fund Results Are as Mediocre as They Sound
One of the biggest gimmicks in mutual fund circles this decade is the development and sales progression of the market-neutral fund. Despite their "catchy" name, these funds are just glamorized mutual funds charging hefty fees that trail the S&P 500 Index. Of the nearly two dozen that I track in the United States, only two have logged respectable, but not earth-shattering returns over the last decade.
Boosted by changes in U.S. securities laws in 1997, the advent of the long/short and market-neutral fund promised to provide market-beating returns because of the ability to short the market amid downturns. Hence, higher returns and lower portfolio volatility, right? Well, lower returns and higher volatility is more like it, especially when the markets tank on any given trading day. This was the case most recently in late February and March when stocks plunged on sub-prime mortgage woes.
And over the last decade, these products have trailed the S&P 500 Index, despite mostly protecting capital from 2000 to 2002 when stocks swooned. But as stocks rose and the index doubled over the last 4.5 years, market-neutral funds actually stayed in "neutral," literally.
The results for these funds are pathetic, considering they should be riding the market with some downside hedging. But the majority of these funds have lagged the market badly, gaining only 5% per annum since June 2002, according to Morningstar . That compares to 10.6% per annum for the S&P 500 Index over the same period, a stock-market capitalized benchmark.
To be sure, there are a few long/short funds have indeed posted good results over the last several years. A few managers even earned big returns in the wretched bear market at the beginning of this decade and deserve kudos. But that's the exception and not the rule for market-neutral funds and long/short funds.
Overall, market-neutral funds and long/short equity funds are a long-term disappointment. Like hedge funds, the majority of these expensive products don't belong in a diversified portfolio. Instead, try short-term bonds, real estate, commodities and currencies - assets that historically provide a negative correlation to common stocks.