Inflation has been ebbing gradually over the past year, following the most aggressive Fed campaign to cool prices in four decades. However, on Thursday, data showed that the consumer price index (CPI) jumped significantly in December. Headline CPI rose 0.3% compared with 0.1% for November, while year-over-year CPI rose 3.4% compared with 3.1% the month before.

Removing food and energy prices, core inflation fell to an annual rate of 3.9% from 4% the month prior. However, the month-over-month number remained unchanged at 0.3%, in line with the consensus.

These numbers come in as a dampener for investor mood. Over the last two months, markets have been anticipating an end to the Fed rate-hike regime, with various indicators showing that the central bank’s restrictive policies have had a sufficient effect on various sectors. The jobs markets had slowed down, prices were in check, and various sectors were feeling the heat, exactly what the Fed was out to achieve.

In fact, at the conclusion of the Fed December meeting, various Fed officials, including Fed Chair Jerome Powell, suggested that rate hikes were probably a thing of the past, and the central bank’s projections showed at least three rate cuts in 2024. This piece of good news took the market on overdrive, as investors speculated that there might be five or six rate cuts in 2024, more than the Fed had cautiously projected, and 2023 ended with a booming Wall Street.

The market has been correcting itself from this overbought position since the first trading of the year, and yet, has remained hopeful that the central bank would start cutting rates as early as March. The December CPI numbers came as a blow to this notion, and investors will now closely monitor what Fed officials indicate over the next few days.

An important Fed official like New York Fed president John Williams said Wednesday that he only sees cuts happening when the Fed is confident inflation is sustainably moving back to its 2% target. Richmond Fed president Tom Barkin, too, expressed the same concern and Chicago Fed president Austan Goolsbee said he also needs to see more data before cuts can begin.

Rising inflation will ensure that the market stays volatile for the time being, and in such an environment,  prudent investors often opt for market-neutral funds. A market-neutral fund seeks profit regardless of an upward or downward movement in the market, typically by pairing long and short positions or derivatives. They are extremely diversified.

In taking up a long position on a stock, one expects its price to increase over time so that it can be sold at a profit. In a short position, the price is expected to go down so that it can be bought later. The strategy involves taking simultaneous long and short positions and utilizing available transactional opportunities.

This strategy balances short positions in losing stocks with long positions in outperforming stocks and is ideal for volatile markets like the one we are seeing currently. These funds also typically aim at attaining zero beta, i.e., the stock price’s movement in correlation to the market. The main objective is to reduce risk and not volatility, as market-neutral funds feed off volatility.

Mutual funds, in general, reduce transaction costs and diversify portfolios without an array of commission charges that are mostly associated with stock purchases (read more: Mutual Funds: Advantages, Disadvantages, and How They Make Investors Money).

We have thus selected three market-neutral funds that boast a Zacks Mutual Fund Rank #1 (Strong Buy) or 2 (Buy), have positive three-year and five-year annualized returns and a low three-year beta, and carry a low expense ratio.

American Beacon SSI Alternative Income (PSCAX Quick QuotePSCAX - Free Report) invests most of its assets in convertible securities that include convertible preferred securities and in establishing short positions, or hedges, in the common stock of the issuers of the convertible securities. PSCAX is heavily exposed to the financial sector.

Three top holdings for PSCAX are 3% in Apollo Commercial Real Estate, 6.3% in MFA Financial and 5.5% in Pennymac. George M Douglas has been the lead manager of PSCAX since May 24, 2012.

PSCAX’s 3-year and 5-year annualized returns are 1.6% and 3.8%, respectively. Its net expense ratio is 1.72% compared to the category average of 1.79%. The 3-year beta score for the fund is 0.13. PSCAX has a Zacks Mutual Fund Rank #2. To see how this fund performed compared to its category, and other 1 and 2 Ranked Mutual Funds, please click here.

Gateway (GATEX Quick QuoteGATEX - Free Report) invests the majority of its net assets in a diversified portfolio of common stocks, while also selling index call options and purchasing index put options.  

Three top holdings for GATEX are 8.1% in Apple, 7.1% in Microsoft and 3.4% in Amazon. Kenneth H. Toft has been the lead manager of GATEX since Feb 20, 2013.

GATEX’s 3-year and 5-year annualized returns are 3.9% and 4.5%, respectively. Its net expense ratio is 0.94% compared to the category average of 1.20%. The 3-year beta score for the fund is 0.05. GATEX has a Zacks Mutual Fund Rank #2.

Calamos Market Neutral Income (CVSIX Quick QuoteCVSIX - Free Report) seeks high current income alongside stability of the principal investment amount by investing in equities and convertible securities of U.S. companies, notwithstanding market capitalization. The average maturity term of the convertible securities purchased by CVSIX usually ranges from two to 10 years.

Three top holdings for CVSIX are 4% in Apple, 3.4% in Microsoft and 1.6% in Amazon. John P. Calamos has been the lead manager of CVSIX since Sep 3, 1990.

CVSIX’s 3-year and 5-year annualized returns are 2.8% and 3.5%, respectively. Its net expense ratio is 1.22% compared to the category average of 1.79%. The 3-year beta score for the fund is 0.21. CVSIX has a Zacks Mutual Fund Rank #1.

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