A Fund Company Gold Rush Into Long-Short

In the fund world, one of the best contrarian indicators is fund launches. When a bunch of fund companies launch funds in the same category, it usually means the sector is overheated, overhyped, and overpriced. There were Internet fund launches in 1999 and 2000 and global real estate launches in 2007. You can see some of the effects here.

Today, the hot category is long-short. We've seen 22 separate long-short mutual fund launches in the past 12 months. A year ago there were only 78 funds in the long-short space.

The problem with hot fund launches is that fund companies are chasing flows, which are in turn chasing performance. By the time one catches up to the other, it's usually way too late.

In this case, it's easy to see why long-short funds are spreading like wildfire. The 2008 bear market was one of the all-time nastiest, so a fund that offsets its long positions with shorts would naturally appeal. Unlike the previous bear market, there really were no places to hide in equities.

Just as with other hot spots, a couple of the more successful entrants have been raking in the money.  Hussman Strategic Growth (HSGFX) is nearing $6 billion in assets thanks to its smallish 9% loss in 2008 and an impressive 3.6% gain so far this year.

Nipping at Hussman's heels is Bill Gross'  PIMCO Fundamental Advantage Total Return , which is nearing $4 billion just two years into its existence. (Thank goodness those kids at PIMCO are going to make a go of it.) The fund's institutional share class launched at the end of February 2008, and it had a marginally positive return that year and is up a nifty 6% this year.

In 2009, long-short funds took in a record $10.3 billion last year and they are on track to break that record this year. Through April 2010, they took in $6.3 billion, which makes it the seventh most popular fund category in 2010.

That is what's inspiring many of the new entrants from Prudential, JP Morgan, Keeley, Dreyfus, Leuthold, and more. Interestingly, Dreyfus was a mutual fund pioneer in this area. Dreyfus Market Neutral was launched more than 10 years ago and was one of the first market-neutral funds around. However, it performed poorly and was snuffed out.

So, will long-short funds suffer the same fate as global real estate and Internet funds? I'm not so sure. This time out, the lagged response was kind of helpful. Sure, some had horrible timing such as Incline Capital Trend Following  and Rydex SGI Equity Market Neutral , which launched on March 30, 2009. (Way to nail the bottom, guys!) However, those that were even later to the game don't look so bad. The market's snap back was so dramatic that we quickly moved from massively oversold to either fairly valued or overvalued, depending on whom you ask.

So, take heart, Prudential Jennison Market Neutral . It might be that you were so late to the last party (April 23, 2010) that you were early for the next.

In addition, long-short isn't as aggressive as Internet strategies are. While their sales appeal is based on a down or flat stock market, they would more likely lag in a rally rather than blow up.

Even so, I'd tread cautiously here. The attrition rate in long-short has been appalling as the strategy has proved to be difficult to execute. Many funds start with a high expense ratio and have proved that they can lose money in most markets rather than make money in most markets. Nearly all of the long-short funds launched in the 1990s have gone away. Remember Calvert, Crabbe Huson, Heartland, or Dreyfus' early entries? Remember the Geronimo funds of more recent vintage? I didn't think so. Make sure you have a good manager with a proven strategy and modest costs before diving in.

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