U.S. stock markets have been volatile for a pretty long time. Market volatility can make anyone feel anxious. It threatens the one thing that everybody holds dear – their money. To weather such market swings and book in profits, alternative mutual funds are the best available choice. Their potential to hedge risks, provide unwavering returns and diversify portfolio helps to stand out from other mutual fund classes, particularly in difficult times. Up-and-Down Markets Since June 30, 2015, concerns regarding Grexit have made the markets volatile. Later, from August 24 to August 27, 2015, the Chinese stock market crash unleashed a downward spiral. Add to it the continuous rout in oil prices, uncertainty about the Fed rate hike and selloff in bank stocks and you know why the U.S. markets have been so unstable. The CBOE Volatility Index (VIX) has been proof enough. VIX is “a key measure of market expectations of near-term volatility conveyed by S&P 500 stock index option prices.” VIX being a fear-gauge index moves contrary to market trends. In the first week of January the index gained 48.33%, while in the second week it gained a meager 0.04%. On the other hand, the index declined 17.32% and 9.58% during the last two weeks, respectively. Come February, the index recorded gains of 15.74% and 8.64%, respectively, in the first two weeks, while in the third week it fell 19.17%. This shows that investor sentiment is constantly fluctuating and the stock market is subject to gyrations. Meanwhile, the VIX settled at 20.72 on Wednesday. Any reading above 20 indicates high volatility in the markets. How to Play This Volatility? The best way to navigate market volatility is by investing in alternative mutual funds, which will not only minimize risk but will also provide stable returns. These types of funds are available to investors of all income levels and provide that extra edge brought by diversity. These funds mostly include market-neutral funds, long/short equity funds and trading-leveraged equity funds. Let us now discuss these three types of funds in some details. Market-Neutral Mutual Funds Market-neutral funds aim to adopt a precision approach by shorting 50% of their assets and holding 50% long. This approach seeks to identify pairs of assets whose price movements are related. The fund goes long on the outperforming asset and shorts the underperformer. Say, for example, you take a $1 million long position in Pfizer and a $1 million short position in Wyeth. Both are large pharmaceutical companies. Now, if pharmaceutical stocks fall, you will lose because of your long position in Pfizer but will gain because of the short position in Wyeth. A market-neutral fund is designed to provide stable returns at relatively lower levels of risk regardless of market direction. This is particularly relevant in today’s highly volatile scenario when the objective is to protect the capital invested. Long/Short Mutual Funds Equity long/short funds seek to gain from both winning and losing stocks, irrespective of the current market scenario. These funds use conventional methods to identify stocks that are either undervalued or overvalued. It profits from shorting the overvalued stocks and by buying the undervalued stocks. Weights are subject to change and are dependent on the management’s view regarding the market. For example: Say an investor buys a long/short mutual fund for $100, then the fund manager will invest it in assets that are expected to do well. The manager shorts $30 in stocks that are believed to be overvalued. In the process, he receives $30 in cash. He will now use the $30 to buy more assets with an upside potential. So, now he has a total of $130 invested in long positions and $30 in short positions. This type of long/short fund is called a 130/30 mutual fund. Trading-Leveraged Equity Funds Leveraged funds use borrowed money to increase returns in a short spell of time. These funds generally strive to return a certain multiple of the short-term returns of an equity index. For example, a 2X S&P 500 fund aims to generate twice the returns that the S&P 500 manages to achieve. Leveraged funds are primarily marked “ultra”, “bull” or “2X”. Leveraged funds also offer benefits such as diversification. These funds invest in a diversified portfolio of assets which minimize risk, while escalating returns. In addition to this, investors enjoy the benefits of “dollar cost averaging,” where a young investor depositing $10,000 in these funds reaps the same benefits a high net worth individual receives, say by depositing $50,000,000. These funds also enjoy tax deductions. 5 Alternative Mutual Funds to Invest In The investment community is a dynamic one where new products will come into play and make the most of the stock markets. In times of market volatility, alternative mutual funds are such new product classes that are equipped to protect investors’ portfolio and provide steady returns. Here we have selected five such alternative mutual funds that boast a Zacks Mutual Fund Rank #1 (Strong Buy) or #2 (Buy), have positive 3-year and 5-year annualized returns and carry a low expense ratio. Calamos Market Neutral Income A (MUTF: CVSIX ) seeks high current income. CVSIX invests mainly in convertible securities and employs short selling to enhance income and hedge against market risk. The fund’s 3-year and 5-year annualized returns are 1.9% and 2.7%, respectively. Annual expense ratio of 1.11% is lower than the category average of 1.7%. CVSIX has a Zacks Mutual Fund Rank #1 and has a minimum initial investment of $2,500. Gateway A (MUTF: GATEX ) seeks to capture most of the higher returns associated with equity market investments, while exposing investors to significantly less risk than other equity investments. The fund’s 3-year and 5-year annualized returns are 3% and 3.5%, respectively. Annual expense ratio of 0.94% is lower than the category average of 1.82%. GATEX has a Zacks Mutual Fund Rank #1 and a minimum initial investment of $2,500. Diamond Hill Long-Short A (MUTF: DIAMX ) seeks to provide long-term capital appreciation. DIAMX invests its assets in U.S. equity securities of any size capitalization that are undervalued and sells short equity securities of any size capitalization that are overvalued. The fund’s 3-year and 5-year annualized returns are 5.4% and 6.3%, respectively. Annual expense ratio of 1.4% is lower than the category average of 1.82%. DIAMX has a Zacks Mutual Fund Rank #1 and a minimum initial investment of $2,500. Aberdeen Equity Long-Short A (MUTF: MLSAX ) seeks long-term capital appreciation with a total return greater than the S&P 500 Index. MLSAX invests a large portion of its assets in long and short positions in equity securities of publicly traded companies in the U.S. The fund’s 3-year and 5-year annualized returns are both 0.1. Annual expense ratio of 1.56% is lower than the category average of 1.82%. MLSAX has a Zacks Mutual Fund Rank #2 and a minimum initial investment of $1,000. ProFundsUltraSector Health Care Investor (MUTF: HCPIX ) seeks daily investment results, before fees and expenses that correspond to one and one-half times the daily performance of the Dow Jones U.S. Health CareSM Index. The fund’s 3-year and 5-year annualized returns are 22.9% and 23.9%, respectively. Annual expense ratio of 1.61% is lower than the category average of 1.99%. HCPIX has a Zacks Mutual Fund Rank #2 and a minimum initial investment of $15,000. A higher minimum investment helps the fund manager to control cash flows, which eventually helps management of assets on a regular basis. Original Post