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Before you dive into these alternative mutual funds though, we need to take a closer look at what they are and what role they can play in your portfolio.
The first type of alternative fund we’ll discuss is the trading-leveraged equity fund. This fund seeks to replicate the returns of its benchmark index at a fixed multiple, generally 2x or 3x returns. So if the benchmark index gained 1%, the leveraged fund would generate 2% or 3% gains. The use of leverage is applied liberally in these funds and can result in extreme short-term volatility. Remember, it might produce returns at an exponential rate, but it also delivers losses at the same pace.
Another common alternative is the long/short equity fund. As the name implies, this fund holds both long and short positions in its portfolio to maximize potential profits from rising and falling markets. The goal here is to generate uncorrelated returns relative to the broader averages and add diversification to your portfolio. Weights can shift throughout the year as management views the markets in a more bullish or bearish light.
Market-neutral funds are similar to long/short equity funds in the sense that they are designed to produce uncorrelated results relative to the broader averages. These alternative mutual funds attempt to generate a neutral position in the markets by shorting 50% of their assets and holding 50% long. The returns on this setup are generally lower than other types of mutual funds, but it’s intended to produce stable returns regardless of market direction. They are low-risk and low-return mutual funds.
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