Long-short funds may be a nice addition to a healthy long-term investment strategy, according to Marta Norton of Morningstar. "Research has shown that adding hedge-fund-like investments to stock-and-bond portfolios has historically led to better risk-adjusted returns over the long haul," she says. But other kinds of assets, like real estate or commodities, work just as well for diversifying a portfolio, she warns. She outlines three major types of long-short funds:
Market neutral – These funds aim for zero broad market exposure, so their long and short positions are offset when the market moves a lot in one direction. They're riskier than the money-market or short-term bond funds they're sometimes compared to, so they don't make for good income replacement funds, according to Norton.
