Is there a mutual fund that is a type of hedge fund? I see funds go either long or short, but wondered if one can do both.

QUESTION: I was wondering if there is a mutual fund that is a type of hedge fund? I seem to see funds go either long or short, but wondered if there was one that can do both.

-- A. Levin

Part of the allure of hedge funds is that they have much more freedom than mutual funds over how portfolios are managed. This means they can short stocks and use options to try to get the best returns. But since this group isn't closely regulated by the SEC, it's very hard to track the performance of these funds. And while fewer restrictions can lead to much more aggressive investment strategies, it can also considerably increase the risk, as demonstrated by the dramatic 1998 blowup of Long Term Capital Management.

There are some mutual funds out there that mimic hedge funds by going both long and short. As you probably know, when you go "long," as the majority of equity funds do, you're betting that a stock's price will rise. But when you "short," you're counting on the price to decline, which carries inherently more risk. Why's that? Your account can drop only to zero when you go long, but you can even end up owing money to your broker when you short.

There are about 15 funds that do this, as well as several "market-neutral" portfolios, which we'll address in a moment. Unfortunately, since these relatively young funds vary widely in their approach, often shorting stocks to varying degrees, it's difficult to say whether this is the way to go if you're looking for protection in a down market.

Funds that are specifically marketed as pseudo hedge funds include the CGM Focus fund (CGMFX), one of the oldest of the bunch, which is managed by Kenneth Heebner. It's up 10.63% year-to-date, and 33.43% over the past three years annualized. Then there's the AIM Small Cap Opportunities fund (ASCOX), which has a terrific three-year annualized return of 35.66%. But it hasn't fought the bear market much better than the average small-cap growth fund, losing 20.19% year-to-date. The AIM Mid Cap Opportunities fund (AMCOX) and AIM Large Cap Opportunities fund (LCPBX) are in similar straits, as is another hedge-like fund, Invesco Advantage (IADAX), which launched just over a year ago. "The downside of these funds is that they are not well proven and have been available only a short time," says Don Cassidy, senior research analyst at fund-tracker Lipper.

Also relatively untested is the handful of market-neutral funds, like Lindner Market Neutral (LDNBX) and James Market Neutral (JAMNX), which traditionally invest 50% of their assets long -- usually in undervalued stocks -- while shorting the remainder of the portfolio, often in overvalued names. Using this strategy, these funds aim to neutralize the market's movements, essentially hedging volatility. While their returns are unspectacular on a three-year basis, it's worth noting that all but one are in positive territory in 2001 -- and that's no easy feat.

If you decide to purchase a fund that shorts -- whether it's an aggressive portfolio or a market-neutral selection -- remember that it should account for only a small part of your assets, much like a sector fund. "When you're shorting stocks, over time you're fighting against somewhat of a headwind," says Scott Cooley, analyst at fund-tracking firm Morningstar. "For most investors who are focused on the long term, it probably makes sense to have pure equity exposure."