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5 Best Alternative Mutual Funds for Skittish Investors

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President Donald Trump's immigration ban and withdrawal from landmark trade pacts could result in erratic share price movement this month. Investors, in the meantime, also assign greater risk premiums to European countries where anti-establishment movements are on the rise ahead of election. Notably, the month of February has traditionally seen weak numbers just after the election.

Alternative mutual funds seem to be the best way out from such a tricky situation. Their potential to hedge risks, provide unwavering returns and diversify portfolio distinguishes them from other mutual fund classes, particularly in difficult times.

Trump Policy Woes

Market bulls argue that Trump's business-friendly policies focused on tax cuts, deregulation and infrastructure spending bode well for the economy, but, investors have got a whiff that the path higher will not be quite smooth.

Trump banned immigration from seven Muslim-majority countries, including legal residents and visa holders. This decision has drawn congressional criticism and widespread protests. These protectionist measures may also cloud the path for pro-business initiatives as several world and corporate leaders condemn the ban. Airlines bore the brunt as well as several airports across the country saw violent protests, disrupting operations to a great extent. Such an executive order on immigration, widely known as the "Muslim Ban", is being met with resistance from an increasing number of major tech firms.

Investors, in the meanwhile, may ignore Trump's trade rhetoric at their own peril. The administration's pledge to protect U.S. industries and redefine currency relationships could lead to a trade war with dire consequences, eventually sparking widespread sell-off. Trump has withdrawn the U.S. from the Trans-Pacific Partnership and is mulling over the imposition of a border tax on imports.

While a highly polarized political environment and Trump's confrontational approach are expected to fuel volatility in the market, investors are also preparing for political upheavals across Europe including French and German election later this year.

February: Traditionally a Weak Month

February has been the weakest month for stocks over the past four decades, averaging just a 0.06% gain. In fact, in election years, February tends to be weaker. The average return has decreased 1.85% since 1977.

Lest we forget, markets have gone 74 days without a 1% daily decline, hence, the seasonality pattern increases the odds of a wider decline in February.

How to Play This Uncertainty?

Investing in alternative mutual funds is the best way to play this uncertainty. These funds mostly include long/short equity funds, market-neutral funds and trading-leveraged equity funds. These types of funds are available to investors of all income levels. Let us now discuss these three types of funds in some details.

Long/Short Mutual Funds

Equity long/short funds seek to gain from both winning and losing stocks, irrespective of the current market scenario. These funds use conventional methods to identify stocks that are either undervalued or overvalued. It profits from shorting the overvalued stocks and buying the undervalued stocks. Weights are subject to change and are dependent on management's view regarding the market.

For example: Say an investor buys a long/short mutual fund for $100, then the fund manager will invest it in assets that are expected to do well. The manager shorts $30 in stocks that are believed to be overvalued. In the process, he receives $30 in cash. He will now use the $30 to buy more assets with an upside potential. So, now he has a total of $130 invested in long positions and $30 in short positions. This type of long/short fund is called a 130/30 mutual fund.

Market-Neutral Mutual Funds

Market-neutral funds aim to adopt a precision approach by shorting 50% of their assets and holding 50% long. This approach seeks to identify pairs of assets whose price movements are related. The fund goes long on the outperforming asset and shorts the underperformer. Say, for example, you take a $1 million long position in Pfizer and a $1 million short position in Wyeth. Both are large pharmaceutical companies. Now, if pharmaceutical stocks fall, you will lose because of your long position in Pfizer but will gain because of the short position in Wyeth.

A market-neutral fund is designed to provide stable returns at relatively lower levels of risk regardless of market direction. This is particularly relevant in today's highly volatile scenario when the objective is to protect the capital invested.

5 Top Alternative Mutual Funds for Your Portfolio

As mentioned above, alternative mutual funds are new product classes that are equipped to protect investors' portfolio and provide steady returns amid market volatility. Thus, we have selected five such alternative mutual funds that boast a Zacks Mutual Fund Rank #1 (Strong Buy) or 2 (Buy), have positive 1-year and 5-year annualized returns, minimum initial investments within $5000 and carry a low expense ratio.

The question here is why should investors consider mutual funds? Reduced transaction costs and diversification of portfolios without the several commission charges that are associated with stock purchases are the primary reasons why investors should park their money in mutual funds (read more: Mutual Funds: Advantages, Disadvantages, and How They Make Investors Money ).

Aberdeen Equity Long-Short AMLSAX invests a large portion of its assets in long and short positions in equity securities of publicly traded companies in the U.S. MLSAX's 1-year and 5-year annualized returns are 7.6% and 2.5%, respectively. Annual expense ratio of 1.59% is below the category average of 1.92%. The fund has a Zacks Mutual Fund Rank #2.

Hancock Horizon Quant Long/Short InvestorHHQAX seeks long-term capital appreciation by taking long and short positions in equity securities of publicly-traded companies in the U.S. HHQAX's 1-year and 5-year annualized returns are 8.9% and 7.5%, respectively. Annual expense ratio of 1.63% is lower than the category average of 1.92%. The fund has a Zacks Mutual Fund Rank #2.

Calamos Market Neutral Income ACVSIX invests mainly in convertible securities and employs short selling to enhance income and hedge against market risk. CVSIX's 1-year and 5-year annualized returns are 8.4% and 3.5%, respectively. Annual expense ratio of 1.22% is below the category average of 1.73%. The fund has a Zacks Mutual Fund Rank #1.

Gateway AGATEX seeks to capture most of the higher returns associated with equity market investments, while exposing investors to significantly less risk than other equity investments. GATEX's 1-year and 5-year annualized returns are 11.5% and 4.7%, respectively. Annual expense ratio of 0.94% is below the category average of 1.51%. The fund has a Zacks Mutual Fund Rank #1.

PIMCO RAE Fundamental Advantage PLUS APTFAX seeks to achieve its investment objective under normal circumstances by obtaining long exposure to a portfolio of stocks and short exposure to the S&P 500 Index, and complementing this equity market neutral exposure with absolute return bond alpha strategy. PTFAX's 1-year and 5-year annualized returns are 7.4% and 2%, respectively. Annual expense ratio of 1.29% is lower than the category average of 1.73%. The fund has a Zacks Mutual Fund Rank #1.

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The views and opinions expressed herein are the views and opinions of the author and do not necessarily reflect those of Nasdaq, Inc.


The views and opinions expressed herein are the views and opinions of the author and do not necessarily reflect those of Nasdaq, Inc.

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