3 Mutual Funds Built for the Next Market Correction
Mutual fund investors often take the speed bumps in stride. They're paying someone else to pick stocks and make asset allocation decisions. They're unloading the stress and learning curve on someone else, but at the end of the day it's still their money that's at risk.
Thankfully, not every mutual fund is built the same. There are actually many vehicles out there that either don't necessarily correlate to the general equities market or actually benefit from a market sell-off. Let's go over a few of these mutual funds that nervous investors convinced that a Wall Street correction is truly coming this time may want to consider.
Merger Fund (MERFX)
A mutual fund with the word "merger" in its name may seem risky, but Merger Fund actually engages in a risk-mitigating practice called arbitrage. Let's say that Paula's Peanut Butter wants to acquire Charlie's Chocolates. The sides can agree on Paula's paying $10 a share for Charlie's, but that doesn't mean that Charlie's goes to $10 immediately. It can go above $10 if the market feels that a bidding war will break out, but more than likely it will trade at a discount given the uncertainty of the deal going through and the months that it may take for the acquisitions to be completed.
That's the situation that Merger Fund embraces. If it can buy Charlie's at $9.50 and wait a few weeks or months for the deal to close at $10, it made a decent return in a short time frame. If a company is buying another in stock -- presenting the opportunity for arbitrage -- Merger Fund can easily buy the one being snapped up and short an equal amount of the acquirer. Things can go wrong: Deals can come undone, the premiums can be meager. However, Merger's 10-year annualized return rate of 3.45 percent is more than reasonable given its low volatility.
There's no shortage of index funds out there, but Gateway does things quite differently. It may buy into the components of the S&P 500, but then it generates income by writing at-the-money call options. You don't have to know what that means. All you need to know is that Gateway is trading in the potential upside of its stocks for the premium paid by an options buyer. It also goes on to use some of those proceeds to buy put options that will grow in value if the market heads south. In short, it holds up a lot better than other funds in down markets even if it misses out on the rallies.
Gateway isn't perfect, but it has posted negative annual returns just three times over the past 15 years. You'll have to pay a load if you buy Gateway directly, but a few discount brokers offering no-transaction-fee mutual funds, including Schwab (SCHW) and Fidelity, can get you into Gateway without paying a load sales charge.
Turner Medical Sciences Long/Short (TMSEX)
There's been an explosion in "market neutral" funds, offering investors the best -- or worst -- of both worlds by buying stocks while selling short stocks that the fund manager feels is overvalued. Turner is an interesting entry in this niche because it focuses on the volatile world of biotechs and other medical companies.
The bar is high just to invest in the fund: The minimum initial investment is $100,000, way above that of most market-neutral funds that are long and short the market at the same time. However, Turner's been able to ring up the highest Morningstar (MORN) rating -- five out of five stars -- in its brief tenure.
Motley Fool contributor Rick Munarriz has no position in any stocks mentioned. The Motley Fool has no position in any of the stocks mentioned. Try any of our Foolish newsletter services free for 30 days. Check out our free report on one great stock to buy for 2015 and beyond.