"The Schwab Hedged Equity Fund has had big swings. It lost more than 20% in 2008 compared to 15.9% for the category, but it is more fairly priced in terms of fees compared to its competitors," says Alpert. Schwab's management fee is 1.33%.

Since inception, Schwab's Hedged Equity Fund return has been 6.79% while the S&P return was 6.49%. "We short sell 20 to 60 cents opportunistically and then the cash we get from shorting is held as segregated cash," says Vivienne Hsu, managing director and portfolio manager of the Schwab Hedged Equity mutual fund. "The fund is diversified across the board so that within the sectors we are picking stocks to go along with the ones we think will underperform the stocks in that sector that go short."

There are nearly 100 mutual funds available in a hedge fund format currently on the market versus 10,000 traditional hedge funds. "Hedged mutual funds act as a diversifier and can both reduce losses or make money. They are designed to return a small amount in any market. In balance, they are good by adding choice and selection to the client's menu," says John Longo, a registered investment advisor in Morristown, N.J. 

The pitfall is the fallibility of the fund's manager. "Sometimes these funds can be wrong in their ability to time the market. The manager may go deeply into a stock at the wrong moment and then the bottom falls out of the market and your hedged equity mutual funds decline in value like the rest of your long-only mutual funds," says Tjornehoj.
The fees for hedged mutual funds are lower than those of traditional hedge funds but higher than those of stock mutual funds. Typically, traditional hedge funds, such as Paulson or Avenue Capital, charge 2% and 20% of any profit.

"On average, hedged mutual fund fees can be as high as 2% compared to 1% for a stock fund and half a basis point for a bond fund," says Longo.

The fee on Rydex hedged mutual funds when investing less than $100,000 is 4.75%.

"The ongoing fee once you're invested is 2.05% per year for Rydex," says Tjornehoj. "It's expensive because of the shorting capability. When you are short on a stock, the shareholder is responsible for paying the dividend that it produces, but hedged mutual funds are still cheaper than traditional hedge funds."

Overall, the role of a hedged equity mutual fund in a portfolio is not for performance but to manage risk.
"The fund is trying to deliver lower volatility. Because of shorting, we net out some of the risk inherent when investing in stock," says Hsu of Schwab's Hedged Equity Fund.

Used to counter the price movements of a traditional investment portfolio, it is the low correlation of hedged long-short mutual fund holdings that provide protection from the market's fluctuation.

For complete non-correlation, Alpert advises investing in the market neutral hedged mutual fund. "Long-short equity hedged mutual funds are going to have a long bias over time. A market neutral fund is going to have no systematic risk because it hedges away all systematic risk through derivative investments to get down to zero beta. Both are considered hedged mutual funds," says Alpert. "Being neutral means removing most of the relationship to broad equity index stocks. That's how market neutral mutual funds have less stock market risk."