There is no disputing the fact that you should make sure your portfolio is diversified so that your wealth and protected. Diversification also helps ensure more positive than negative returns. What you do to diversify your portfolio, however, is the harder issue.
Different investors prefer different strategies. Many consider hedge funds as better at handling risk because there are more types of investment available to them. The problem is that most hedge funds are not available to individual investors. Nevertheless, there is a type of mutual fund that does include a common hedge strategy, short selling.
Long and short positions: how they work
Normal mutual funds, no matter their investment targets (type of securities, industry sectors, etc.), will take a long position. Going long is how most will consider investing – buy low, sell high.
There are those who also look for short positions, making money on the loss in value. An investor borrows a certain amount of a stock when they are at one price then sells them (for example, 100 shares at USD2 each for a total value of USD200). He must replace those stocks (not the value), so when the value drops, as he expects, he buys them back at a lower price and returns the stock (continuing the example, buying the same shares at USD1 each for a total of USD100). The difference between the value borrowed and the value bought is the profit (in this example, USD100).
Combining long and short positions in a mutual fund
Certain mutual funds will use both long and short selling strategies together to mitigate risk. Usually, these funds will favour the long position and use a short position to protect that long position. There are many different ways to deploy this combination, such as going long on one automotive company and going short on a competing automotive company. Of course, the assumption is that company chosen for the long position will increase in value and the other will decrease.
So, this tool that once was used mainly by hedge funds has seen an increase in mutual funds, adding long/short funds to the growing list of mutual fund types an individual investor can choose from.
Is this a sure-fire bet?
If you look at any list of long/short funds, you will probably find the same range of success from negative to double digit returns. “Long/short funds are just another option, but as with all funds and investment opportunities, they are not all created equal,” explains Richard Cayne. “Read, learn, and discuss the details of any fund you think would be a worthwhile investment. A little care early on may save you a lot more later on.”