Hedging without getting clipped: some funds offer the benefits of hedge funds without the high fees.

Some people would have you believe that in order to get investing profits in a bull or bear market, you have to invest in hedge funds. But these vehicles, which are prized for delivering "absolute returns," are not for everyone. Some hedge funds only accept millionaires and six- or seven-figure minimum investments are common. Hedge funds are largely unregulated, their fees are high, and liquidity is low. For the average investor, there has to be a better way.

Dan McNeela a senior analyst at mutual fund tracker Morningstar, says, "A few mutual funds provide [hedge fund] strategies to investors." Investing in these hedge-fund-like mutual funds can be done for as little as $1,000, and you can cash out whenever you like.

"Long-short" funds buy, or go long on, stocks they think will appreciate while simultaneously selling, or going short on, stocks they think are overpriced. (If you sell short on a stock at, say, $25 per share and then close your position once the stock drops to $15, you'd have a $10-per-share profit.) Such an approach is considered less risky than investing in most stock funds because short positions may deliver gains in a bear market.

"Although Iong-short funds are generally less volatile than traditional stock funds, they still can be risky. A manager's Iong picks might be losers, while the short positions may go up in value," says McNeela. "Therefore, you'll see large variations among long-short funds." In 2003, for example, Choice Long-Short Fund lost 16.6%, while ICON Long-Short Fund gained 17.7%.

So-called "market-neutral'" funds also go long and short. "While long-short funds tend to tilt toward the long side," says McNeela, "market-neutral funds keep a 50-50 balance. Half of the money is long, while the other half is short."

Even with such a split, there's always a chance that a market-neutral fund will be long on stocks that aren't performing and short on stocks that are. For example, if tech topples while healthcare skyrockets, such a market-neutral fund could have a disastrous year.

Some market-neutral funds, therefore, aim for sector-by-sector neutrality. If it buys long on Pfizer, for example, it might sell short on Merck The goal is to reduce the effects of industry and broad-market swings by consistently generating positive returns via savvy stock-picking. "In practice, market-neutral funds have largely lived up to their billing by diversifying investors' portfolios," says McNeela, "They've often lagged behind the market during good years but beat the market in bad times." McNeela advises investors to look closely at the techniques used by each type of fund.

Still other types of hedging strategies may be accessed through mutual funds. There are bear funds that are primarily, if not entirely, short sellers. A relatively new fund, Alpha Hedged Strategies Fund, follows multiple techniques. Several subadvisers manage a portion of the portfolio, pursuing strategies ranging from convertible bond arbitrage to distressed securities. "This fund has a low minimum investment and daily liquidity," says Alan Weiss, president of Regent Wealth Management Group in Woodbridge, Connecticut. "So if you have a desire to invest in an alternative investment that doesn't follow the U.S. stock market too closely, then this may be an investment for you to consider."

For mutual funds that can help diversify your holdings, Lon Morton, an investment adviser in Calabasas, California, recommends: Alpha Hedged Strategies and Merger funds, Schwab Hedged Equity Select, FPA Crescent, Hussman Strategic Growth, Analytic Defensive Equity, Robeco Boston Partners Long/Short Equity, and PIMCO All Asset All Authority. "If you put a few of them together," he says, "you can get some of the benefits of hedge funds."

Keep in mind that an investment in a hedge fund is ultimately a bet on the manager's ability, and the same is true for hedge-like mutual funds. Before investing, look for evidence that a fund's manager has a proven track record.

TOP HEDGE-LIKE MUTUAL FUNDS

                                    1-Year       3-Year       5-Year
                                  Ann. Total   Ann. Total   Ann. Total
Fund Name                Ticker    Return *     Return *     Return *

ICON Long/Short I        IOLIX       9.15        17.29           NA
FPA Crescent             FPACX      10.54        14.67        18.58
Hussman Strategic        HSGFX       6.20        11.24        13.41
  Growth
Robeco Boston Partners   BPLEX      20.19         7.18        11.33
  Long/Short Eq Inv
Arbitrage R              ARBFX       1.17         4.91         6.99
Merger Fund              MERFX       1.84         4.51         1.86
Analytic Defensive       ANAEX         NA           NA           NA
  Equity A **
PIMCO All Asset All      PAUAX         NA           NA           NA
  Authority A **

                           Initial      Toll-Free    Expense
Fund Name                Investment       Number      Ratio

ICON Long/Short I          $1,000     800-764-0442     1.74
FPA Crescent               $1,500     800-982-4372      1.4
Hussman Strategic          $1,000     800-487-7626     1.24
  Growth
Robeco Boston Partners     $2,500     888-261-4073     3.17
  Long/Short Eq Inv
Arbitrage R                $2,000     800-295-4485     1.95
Merger Fund                $2,000     800-343-8959     1.87
Analytic Defensive         $2,500     866-777-7818       NA
  Equity A **
PIMCO All Asset All        $5,000     800-426-0107       NA
  Authority A **

* AS OF NOV. 30, 2006 SOURCE: MORNINGSTAR INC. MORNINGSTAR MAKES EVERY
EFFORT TO ENSURE THE ACCURACY AND COMPLETENESS OF THIS DATA, BUT CANNOT
GUARANTEE IT. ** FUND HAS OPERATED LESS THAN ONE YEAR.