Act Rich and Protect Yourself from a Down Market

August 10, 2007

Important Money-Guy.com news!!! Due to the success of our podcast I have been offered a radio show on Atlanta’s Business Radio station AM 1160 (Follow the attached link to check out the station) I will be on air Monday’s 11AM to Noon starting in September.  Since so many of you are math minded you have probably already figured out that this also means that you will get twice as much of me since I currently only do shows every other week. The Money-Guy.com podcast format will change slightly since my shows will now be broadcast on both iTunes as well as AM 1160, but I think that this is a tremendous opportunity and I owe you the listeners and subscribers a big thank you!  On another matter I am also in discussion with the Fox Business Network to be a contributor.  I am not sure if anything will come of it, but it is pretty cool that this hobby that I started because I love technology and feel that most Americans are not getting good advice has led me to a radio show and potentially exposure through a television network. THANKS AGAIN FOR YOUR SUPPORT!!!

The financial markets have a been a roller coaster for the last few weeks, and by all indications this could continue for quite sometime. It is times like this you need to make sure that you have not been too ambitious with your level of risk, and also an opportunity to make sure that your idea of diversification extends beyond traditional stocks, bonds, and cash holdings. Diversification is the element of your portfolio that is going to let you consistently take 2/3 to 3/4 of the upside profits of a rising market, but limit your loses to less than 50% of the overall market.

On today’s show I am going to be discussing the benefits of using Long/Short Funds.  As many of you are aware I am a partner at a Wealth Management Firm on the south-side of Atlanta.  We also have an office in Augusta, Georgia and it is run by my partner Bill Cleveland.  I have always said that Bill is the smart partner and I am the loud partner.  Bill has an article in the July 20, 2007 issue of Medical Economics titled, “Make Money with Long/Short funds” and the timing of this article could not be any better (Follow the attached link to see the full article). After listening to our show and then reading Bill’s article you are going to see that this asset class could be just what your portfolio needs to weather this type of uncertain market.

So what is a “Long/Short” Mutual Fund – A long/short fund takes advantage of a technique that many hedge funds use that allows them to make money in both a rising and falling market. Long/short fund managers divide their funds’ assets into two types of positions (long and short holdings).

Long positions – meaning they buy stocks expecting that they will rise in value and can be sold at some point in the future at a gain (this is the traditional form of investing that most investors are use to… buy value priced stocks with the anticipation of selling for a gain).

Short positions.  This technique allows managers to make a profit by anticipating a stock price decline, and then “selling short.” (The short seller borrows shares of a stock whose price may drop and immediately sells them, betting that they will be able to replace the borrowed shares with new ones bought at a lower price and pocket the gain from the decline).

This type of money management is complex, but it can provide downside protection if the market hits a down period.  Consider the following examples:

Hussman Strategic Growth Fund made 14% in 2002 when the S&P 500 dropped 22%
Merger Fund returned 18% in 2000, a year the S&P 500 dropped over 9%

Using these funds provides you with a similar type of diversification that the wealthiest families are using in their private hedge funds without having to meet accredited investor status (fancy way of saying that you have a high net-worth or at least earn a large annual income).

When I talk about this asset class I refer to them as “Absolute Return” funds because as mentioned earlier they look to make money no matter what the stock market is doing.  This is different from traditional mutual funds and their stated goal of “relative” performance (meaning they are just trying to beat an index). A good example that Bill provides in his article provides that if the S&P 500 was down 15%, and a traditional actively managed mutual fund dropped just 10%, on a relative basis, that fund beat the market by 5%.  However, on an absolute basis, the fund was still down 10%.

You are probably thinking to yourself that all of this is great, but what about the risk of these funds?  Over the last 10 years Long/Short funds have returned 7.3% with only slightly higher risk than a 10-year Treasury note, which now yields less than 5%.

Is there a downside or weakness to this type of investment? The short answer is yes.  When the broad stock market is having a big run, long/short mutual funds will not share in as much of the gains.  In 2003, the S&P 500 make nearly 29% while long/short fund overall gained just over 9%. For this very reason I would use this asset class for 10% to 20% of your portfolio.

So what should you look for in a good Long/Short Fund?
* Expense ratio that is lower then the group’s average 2.2% average.
* Fund’s annual returns should be in the black, or minimally in the red, even in steeply down market years
* Since these funds should make money even when the market’s dipping they should have a low “correlation” with the broad stock market.

My partner Bill lists three funds that meet this search criteria.  They are:
* The Gateway Fund (click here for their site and research)
* Hussman Strategic Growth Fund (click here for their site and research)
* Merger Fund (no website is available) 800-343-8959

I also have a fund that has a horrible MorningStar® Rating (their performance has struggled through the recent good market), but I am going to let you guys know about it because it was my darling fund back in 2000. It is also an Atlanta based Fund company.
* Caldwell & Orkin Market Opportunity (click here for their site and research)

The 3rd Quarter’s Wealth Report covers the following topics:
** The Dollar Is Weak and It has Affected US Investors
** Avoiding Mistakes on IRA Rollovers
** Update on College Savings Plans
** Eight Ways to Save on Life Insurance
** Why You Should Avoid direct Debits



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