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Buy These Funds to Beat a Choppy Q4

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Unlike the previous two years, 2015 has turned out to be very frustrating for investors. It has been a bear story so far with the downtrend intensifying every passing quarter. August was particularly disturbing, when the market rout dragged the Dow & S&P 500 to their correction territories.

In the third quarter, the Dow, S&P 500 and Nasdaq declined 7.6%, 7% and 7.4%, respectively. As for mutual funds, just 17% of mutual funds managed to finish in the green. This is a slump from 41% in the second quarter, which was again a sharp fall from 87% of the funds ending in positive territory in the first quarter.

Unfortunately, we are not too bullish about the overall trend in the fourth quarter as well. Rather, lingering concerns from the third quarter may continue to disrupt the markets. Moreover, we are all too aware of the increased volatility that has worsened the investment climate in recent months.

Market movements may yet again be volatile as investors continue to grapple with global growth worries, oil’s decline notwithstanding the momentary upsides, and a looming Fed lift-off. Three primary questions will keep the volatility alive – firstly, when will Fed hike rates; will China continue to negatively impact markets; and is the Bull Run over.

As we move into the fourth quarter, Market Neutral mutual funds, Long Short mutual funds or Bear market funds should be the best picks at the moment. Market Neutral funds maintain a low correlation to market trends, helping to beat the volatility.

Before we pick these funds, let’s look at the economic conditions:

China, Global Growth Fears Linger

The International Monetary Fund (IMF) has yet again trimmed the global economic growth projection. IMF’s latest World Economic Outlook (WEO) projects global economic growth of 3.1%, down from prior expectations of 3.3%.

Slowdown in the emerging markets is largely to be blamed for the world economy expanding at its weakest pace since the financial crisis. Emerging markets are now expected to grow at 4% in 2015, down from the previous projection of 4.2%. Modest growth in the U.S. and a small recovery in the Eurozone won’t be strong enough to stem the declining trend in the emerging markets.

Maurice Obstfeld, the IMF’s new chief economist, stated: “Six years after the world economy emerged from its broadest and deepest postwar recession, a return to robust and synchronized global expansion remains elusive.”

The downward projection comes after China-led growth concerns have already wreaked havoc. A number of economic data out of China had confirmed that the world’s second largest economy was shaky. In China, lower-than-expected investment and factory output, dismal manufacturing data, significant trade gap and decline in foreign exchange reserves were among the dismal reports. Asian Development Bank’s (ADB) weak economic outlook for China also dented investor sentiment.

China’s key benchmark moved down to the 3K level, from the 5K level enjoyed by the Shanghai Composite Index in early June. China Region fund category was the third best gainer in the first half of 2015, but the market rout has now made it the third biggest loser in the third quarter.

Government measures to prop up markets did not have much success in China. However, it must be noted that the Chinese government has been implementing financial reforms, fiscal reforms and structural reforms for sustaining long-term growth. The implementation may have slowed growth in the short term. Going forward, it seems that support measures announced by the government hold the key to market movement. Investors need to look for such indications before placing their bets.

Fed Rate Hike in December?

The hullabaloo about the September rate hike was put to rest after the policy makers decided against a lift-off. However, while 9 out of 10 policy makers voted in favor of keeping the rate at the near zero level; 13 out of 17 committee members indicated that a rate hike may be possible this year. The chance of a rate hike in December was further fueled by Federal Reserve President Dennis Lockhart’s hawkish comments.

Lockhart said: “As things settle down, I will be ready for the first policy move on the path to a more normal interest-rate environment. I am confident the much-used phrase ‘later this year’ is still operative.”

Meanwhile, weak jobs report for the month of September raised speculation that the Federal Reserve may become more circumspect about raising rates this year. The Fed has been keeping an eye on further improvements in the labor market for hiking interest rates. Ultra-low interest rates have aided economic recovery and helped the markets enjoy a bull run.

How to Beat Uncertainty in Q4

Market neutral funds aim to invest in bullish stocks and an equivalent number of bearish stocks. The objective is to generate above-average returns at relatively lower levels of risk. In fact, this category of funds adopts a precision approach to long-short investing, by ignoring the market’s direction. This is particularly relevant in today’s highly volatile market scenario when the objective is to protect the invested capital.

This approach aims to identify pairs of assets whose price movements are related. Subsequently, the fund goes long on the outperforming asset and shorts the underperformer. Market neutrality is achieved by allocating the same proportion of assets to both positions. These funds may not offer robust gains, but they may be safe picks in a volatile market.

Below we present three Market Neutral mutual funds that carry a favorable Zacks Mutual Fund Ranks. The following funds carry either aZacks Mutual Fund Rank #1 (Strong Buy) or Zacks Mutual Fund Rank #2 (Buy) as we expect the funds to outperform their peers in the future. Remember, the goal of the Zacks Mutual Fund Rank is to guide investors to identify potential winners and losers. Unlike most of the fund-rating systems, the Zacks Mutual Fund Rank is not just focused on past performance.

The minimum initial investment is within $5000. These funds carry low beta and are in the green over year-to-date and 1-year periods. The 3- and 5-year annualized returns are also favorable.

Calamos Market Neutral Income A (CVSIX - Free Report) invests in equity securities of domestic companies irrespective of their market capitalization. CVSIX also employs short selling to reduce market risk and generate more income. Its average maturity varies within the range of 2 to 10 years. CVSIX may also invest a major portion of its assets in junk bonds.

Calamos Market Neutral Income A carries a Zacks Mutual Fund Rank #1. While the year-to-date and 1-year returns are 0.4% and 2.6%, respectively, the respective 3- and 5-year annualized returns are 2.6% and 3.6%. CVSIX’s 1- and 3-year beta scores are -0.31 and 0.05, respectively. Annual expense ratio of 0.94% is lower than the category average of 1.84%.

TFS Market Neutral seeks capital growth while having minimum correlation to the domestic equity market, or the S&P 500 Index, as defined by the advisor. TFSMX mostly invests in common stocks traded on the US exchanges, irrespective of their market capitalization, sector or style. However, average capitalization of TFSMX tends to be in the small-cap range. A maximum of 25% of its assets may be invested (as long and short positions) in other registered investment companies ("RICs").

TFS Market Neutral carries a Zacks Mutual Fund Rank #2. While the year-to-date and 1-year returns are 1.4% and 4.3%, respectively, the respective 3- and 5-year annualized returns are 3% and 3.4%. TFSMX’s 1- and 3-year beta scores are 0.02 and 0.14, respectively. Annual expense ratio of 2.02% is however higher than the category average of 1.62%.

Gateway A (GATEX - Free Report) seeks to achieve maximum return from the equity markets at less risk. The fund focuses on acquiring common stocks to add to its well-diversified portfolio. The fund invests a significant share of its assets in index call options in order to reduce volatility and maintain steady cash flow.

Gateway A carries a Zacks Mutual Fund Rank #1. While the year-to-date and 1-year returns are 1.4% and 4.5%, respectively, the respective 3- and 5-year annualized returns are 4% and 4.6%. GATEX’s 1- and 3-year beta scores are 0.4 and 0.36, respectively. Annual expense ratio of 0.94% is lower than the category average of 1.84%.

About Zacks Mutual Fund Rank

By applying the Zacks Rank to mutual funds, investors can find funds that not only outpaced the market in the past but are also expected to outperform going forward. Pick the best mutual funds with the Zacks Rank.

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