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These Alternative Funds Have Delivered

Using unconventional approaches, these funds have beaten a flat market during the past five years.

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Alternative mutual funds are touted as a way to bring nontraditional investing strategies such as those used by hedge funds to individual investors while adding diversification to and/or reducing volatility in their portfolios. In a time of lackluster stock returns and low yields on fixed-income vehicles, these relative newcomers to the mutual funds menu have been garnering attention from those seeking to break out of the traditional stock/bond portfolio mix. In fact, alternative funds saw the second most net inflows of any fund asset class last year, adding $12.2 billion (taxable bond was far and away the leader, adding $130.2 billion, while U.S. stock funds saw the greatest outflows at $84.7 billion). In the first four months of 2012 alternative funds added another $3.5 billion in net inflows, with total fund assets estimated at $73 billion as of April 30.

Alternative funds come in many different varieties, and Morningstar has developed category designations that allow for apples-to-apples comparisons of various approaches. (Full descriptions of these alternative fund types may be found beginning on Page 25 of The Morningstar Category Classifications document.) Some alternative funds provide access to nonstock, nonbond investment vehicles--such as currencies or precious metals--while others utilize trading strategies designed to provide downside protection against a falling equity market and/or to reduce volatility. Among these fund types are long-short equity funds, which hold both long and short positions in stocks; market-neutral funds, which hedge out most equity market exposure by taking offsetting long and short positions, thus zeroing in on nontraditional risk factors, such as illiquidity or event risk; and bear-market funds, which primarily use short positions in anticipation of stocks declining.

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Adam Zoll does not own shares in any of the securities mentioned above. Find out about Morningstar’s editorial policies.