At a time when financial advisors are scrambling for alternative investments, the new breed of retail long-short funds-vehicles using some contrarian or bear-market strategy-has produced less than stellar results. In what should be a good environment for these funds, several advisors and managers concede that they have yet to make an effective case for their opportunistic, bear-market investing style.

"I'm leery of this whole concept. These funds, to me, have the mind-set of a casino; they remind me of the limited partnerships of the 1980s," says Ram Kolluri, a certified financial planner with Global Value Investors in Princeton, N.J.

Marketed as packaged hedge funds for Joe Six-Pack, in effect, many of them look for train wrecks-companies that will underperform consistently, often in industries with problems. With the ability to use some form of shorting in their charter, long-short funds are designed to thrive in bear markets when lots of things head south fast.

Several fund managers set their goal as attaining the obverse of the S&P 500 or some other index. When market indexes are down, say 10%, these funds should be up 10%.

"These funds are usually used by investors who want to fine-tune their portfolio during a good market," says Charles Tennes, a portfolio manager with Rydex Funds, which has several bear-market funds.

Long-short funds supposedly offer small investors many of the same benefits as those enjoyed by yacht owners who plunk down $1 million or more to invest in small private funds that use traditional hedging techniques to prosper when markets are depressed and leverage to earn bigger-than-average returns when they are up.

"Somebody with just $4,000 or $5,000 to invest should not be getting into these funds," says Ronald RogÈ of R.W. RogÈ & Co. in Bohemia, N.Y. RogÈ has no clients in retail hedge funds. He once considered a retail hedge fund and passed it up. "What got me was the tremendous expense ratio of these funds, and also, managers are making a big bet. It's tough for the average investor to get over those two hurdles."

Retail long-short funds are for people who are contrarian and market timers, who want bear-market protection or seek some other risk-management objective. When they are well-run, the funds can provide a good hedge in poor markets, Tennes adds. Still, it can be an incredibly rocky ride. For instance, Rydex Velocity 100, which shorts the Nasdaq 100 Index, was down 57% for the year through June 30. However, it had gained 22% in the second quarter. But since its inception, in late May of last year, the fund was down some 77% through early July.

Recently, the numbers of these relatively new funds have not been good. Some examples cited by Morningstar analysts include Invesco Advantage Fund, which was down 16.3% in the first half of this year. Montgomery Global Long Short Fund was down 14.3%, and Caldwell & Orkin Market Opportunity Fund lost 4.7% in the six-month period ended June 30. Some of these funds have been foundering for the last year. For example, Montgomery Global Long Short was down by 34.4% for the year through June 30. Nevertheless, in 1999, the fund made great long and short bets on technology and telecom stocks and had a return of 135%. Not surprisingly, Montgomery has an alpha of 19, a number that reflects short-term developments because these kinds of funds tend to trade so much. The fund also has a 200% turnover, which is not unusual for long-short funds.

Long-short funds use slightly different variants of a strategy of trying to pick the right times to go long and short. "Not all shorting funds are alike. The category isn't really well-defined yet," says Dan Kern, one of the managers of the Montgomery long-short fund.

But all these funds are making big bets. None of these funds is allowed to make the monster bets that many traditional hedge funds do. Some funds require managers to match long and short positions. They must do it in terms of the amount of assets, sector weighting, market caps or some other measurement. But Montgomery Global gives its managers more leeway than some other retail hedge funds because they can go 100% long or 100% short.

Normally, the Montgomery fund has at least 65% of its portfolio in long or short positions. The fund managers also have complete freedom to go net short or net long in individual sectors or countries, a feature the fund has used in the past. Although the fund recently had no options, it still has the power to use them. It can and has used restricted, illiquid securities. The fund also has an expense ratio of some 280 basis points.

Other long-short funds have what some might call a more restrained approach. For instance, Caldwell & Orkin Market Opportunity sets strict guidelines for a fund's long and short weightings. Although the formula has been changed, the fund's short weightings recently were limited to no more than 40%. The fund also was barred from using leverage and emerging-market issues.

Given a sluggish stock market in which the Nasdaq recently had lost some 60% of its value, investment companies have been looking at these kinds of funds as a major new growth area. "I expect there will be many investors to get in on hedge funds in the next few years," says Pat Adams, president of the Choice Funds, which began a long-short fund late last year.

"Lots of these funds have small minimums. We're now seeing democracy in hedge funds," adds Rick Lake, who owns Lake Partners, a registered investment advisor in Greenwich, Conn.

But democracy, with all its virtues, also can have plenty of problems. "These retail hedge funds have done poorly so far. Not only have the returns been bad, but the expenses on these things are often very high," says Gabriel Presler, an analyst with Morningstar.

"It's like anything else. In the right hands, these funds are a wonderful vehicle. In the wrong hands, they will self-destruct," comments Walter Harrison, manager of the Granum Value Fund, which was up, 6.6% in the first half of this year, at the same time the S&P 500 was down 6.7%.

Harrison and others warn that retail hedge funds can easily be misunderstood. For example, Harrison says that aggressive shorting can artificially pump up short-term alpha funds, leading the manager to inflate his or her record. One manager, noting the high turnover numbers in these portfolios, points to the problem of window dressing, of portfolios that do not accurately reflect the philosophy of the fund.

So is there a chance that hedge funds, now more commonly marketed to individual investors, provide investors an opportunity to prosper during tough times? "Well, that's the theory at least," says Jeff Molitor, a Vanguard executive. "However, I believe that most investors would be much better off just diversifying with a bond fund. It is also much cheaper than using a hedge fund as protection against a bear market," he added.

Other industry observers argue that, besides fixed income, another option for worried investors might be just to move some assets into value funds. Managers running retail long-short funds, even in praising the industry for making their technique available to the average investor, caution advisors to be very careful. "I don't think a 50-year-old wage earner should be putting his IRA money in this kind of fund," says Rydex's Tennes.

Vanguard has only one fund that has some hedging options, the Vanguard Capital Opportunities Fund, which was down some 2% for the first half of the year. Molitor warns that retail hedge funds-whether they come in the retail or the traditional partnership wrapper- only are appropriate vehicles for investors with much experience, knowledge and, most of all, patience. "You would have to be out of your mind to get into one of these things on a short-term basis," he says. On the other hand, that is precisely what many managers tell clients to do in these funds: Use them as short-term vehicles to take advantage of unique opportunities created by periodic volatility.

Besides mediocre performance, another problem facing these funds is their short history. Two veteran fund managers, Ezra Mager and Jim Torrey of the New York-based Torrey Associates LLC, last year published a list of a few tips for investing in hedge funds. The tips include: Derivatives are "like nitroglycerin. Avoid touching them." Be careful about how much leverage the fund is using, they noted. "Too much borrowed money," they write, "means that during adverse times you don't control your portfolio. Your clearing broker does."

The other big issue for these funds is the lack of a clear categorization, Morningstar's Presler notes. She says that because there still are relatively few of them-she listed about 10 major retail funds that use hedging and that Morningstar follows-they have no categorization or common strategy that would allow an advisor to compare one with another.

Although Montgomery's Kern agrees that these retail hedge funds are performing poorly, he says that "the opportunity is still huge for these funds to do well in bad times. You can use these as a bear-market protection and to be able to work both sides of the street." Nevertheless, he notes, his fund has had a mixed record: It was quick to react to trends in 1998 and 1999 but slow to take advantage of market volatility last year. While Montgomery managers saw the downturn in technology and telecom coming last year, they underestimated the speed and magnitude with which it happened.

Montgomery Global Long Short Fund has one of the longer histories in this group and a respectable, but roller-coaster-like record. It has a three-year record-it was recently up 18.5% for the three-year period through June 30-but it has no five-year record.

"The only thing you can do is read the prospectus carefully and find out if you agree with that philosophy," notes Chuck Zender, manager of the Leuthold Funds' Grizzly Short Fund, which is one of the few funds that performed well recently. It was ahead for the year, some 21% through June 30.

Monitoring long-short funds is difficult. The Grizzly Short publishes its holdings on a monthly basis, but Leuthold officials concede that as much as 80% of the portfolio can turn over in any given week.

The number of managers and investors trying this style of investing for the first time creates a kind of the blind leading the blind scenario. Zender, who wants investors to come in and out of the fund taking advantage of periods of opportunity for shorting, maintains the last few months have been difficult for retail long-short funds.

"The easy money was made last year between March and June. Since March of this year, it has been tough," he notes. Things change fast, he warns, because these funds often have a very small range of holdings. For example, although this year has generally been good for his fund, in April the market started to recover-with the S&P up about 6%-and Grizzly Short Fund lost about 12%. But when the reverse happens, the market tanks, Zender insists that "these funds must then make a bunch of money or they're never going to make it."

Zender also says that new funds should be able to point to managers with long records running private hedge funds, as well as an impressive track record using the strategy that is proposed for the fund. Even the managers who have performed well within this ill-defined group of funds, agree that these investments are a big bet.

Given that there are many other less exotic ways to diversify and survive a bear market-fixed income investments, hard assets and even increasing the cash component of a portfolio-several industry observers say the best move for advisors might be to steer clients clear of these relatively new investments. Wait, they say, until there is a longer, clearer and more successful history.