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Pursuing a Strategy of Buying High, Selling Low and Vice Versa

Proponents of 'market-neutral' funds see them as a hedge against the volatility of traditional portfolio management.

July 21, 1998|RUSS WILES | SPECIAL TO THE TIMES

It's an elusive goal: making money in both rising and falling markets.

Yet a small number of mutual funds are striving to do just that by simultaneously buying some stocks while betting against others. These are termed "market-neutral" funds, in the sense that they aim to make money whether the overall market goes up or down.

Thanks to a change in the tax code, more mutual funds can use "short selling" to bet on a stock's price declining. The process involves borrowing stock from a brokerage and selling it, hoping to buy the shares back later at a lower price, thereby closing out the position at a profit. It's the reverse of the normal buy-now, sell-later approach known as going "long" on a stock.

Short selling is riskier than making a long purchase because there's no limit to how high a stock's price can climb (and there are higher transaction costs).

But proponents say that when coupled with regular stock investments, shorting can help reduce a portfolio's overall volatility and guard against steep market declines.

"By taking long and short positions in different stocks with similar characteristics, the fund attempts to cancel out the effect of general stock market movements," reads the prospectus of the Barr Rosenberg Market Neutral Fund.

Barr Rosenberg, which manages more than $7 billion, primarily for private clients, uses computerized models to rank stocks in terms of investor sentiments, profit changes and fundamental factors.

The models evaluate trade-offs between risks, returns and potential trading costs to determine which stocks to buy or short. A computerized model "optimizes," or adjusts, the holdings every few minutes based on price changes and trading information.

On long positions, the fund's managers are trying to spot undervalued stocks likely to rise in price. On short positions, they're aiming to select those headed for a fall.

"Rather than buying low and selling high, a market-neutral fund achieves its returns through buying low and selling short," observes the Value Line Mutual Fund Advisor newsletter in New York.

The no-load Barr Rosenberg portfolio ([800] 447-3332; $2,500 minimum) carefully balances its long and short positions in an attempt to reduce market and sector risk. Notably, the fund's managers view 90-day Treasury bills, rather than the Standard & Poor's 500 or another stock market index, as their performance benchmark. They emphasize that the fund, unlike Treasuries, will fluctuate in price.

Barr Rosenberg, which is based in Orinda, Calif., has attracted nearly $300 million in its market-neutral fund since a mid-December launch, including $50 million purchased by individual investors. With the stock market seemingly overvalued, people are listening to the volatility-dampening message.

Barr Rosenberg says its privately managed market-neutral accounts generated an average 8.04% annual return from March 1989 through November 1997. But the new fund is off to a slower start, with a return of just 0.4% for retail shares during the first half of 1998. The fund's institutional shares fared only slightly better. However, some are forgiving. Ken Gregory, publisher of the the No-Load Fund Analyst Newsletter, says he thinks the fund's strategy is worthwhile--although lately it is "trying our patience."

While Barr Rosenberg is unusual in its pure market-neutral stance, a few other funds also make significant use of short selling. One of the most interesting is the Montgomery Global Long-Short Fund in San Francisco, which counts $42 million in assets following a Jan. 1 launch.

This fund can sift through markets around the world for undervalued or overvalued shares. "Emerging markets, with their high volatility, work very well with this type of portfolio," said Nancy Kukacka, co-manager of the Montgomery fund.

Because the Montgomery fund isn't balancing its long and short positions as rigorously as the Barr Rosenberg portfolio, it doesn't meet the true definition of a market-neutral investment, with the low volatility implied.

"We're not claiming to be making the big calls that will enable us to make money in every type of market," Kukacka said.

Currently, the Montgomery fund is holding more long positions than short in Europe, and the reverse in Asia. It's roughly neutral in the U.S., with similar weightings of long and short positions.

Montgomery Global Long-Short ([800] 572-3863; $2,000 minimum) is off to a much better start than the Barr Rosenberg fund, with a blistering 40.2% surge during the first six months of 1998. To reiterate, though, the latter fund is likely to exhibit greater risk.

Notably, the Montgomery fund carries a 5.5% sales charge--evidence that management views the concept as complex enough that they would expect most investors to buy it with the help of a broker or financial planner.

A few other mutual funds have also made significant use of short selling in recent years, with mostly unimpressive results.

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