The recent volatility in equity markets is a result of an uncertain trade policy between U.S. and China, which is likely to affect the stock markets ahead. Investors could find alternative mutual funds ideal in such times of turbulence by virtue of their investment strategies and holdings.

Is a Healthy Domestic Economy Enough to Push Markets?

The U.S. economy has been faring well since the beginning of this year. The economy expanded at an annualized 3.2% in the January-March period, the latest job report (April) registered significant new job additions and consumer confidence climbed higher last month.

In addition, inflation was largely in check. As a result, the Fed has been particularly easygoing on the rate front, opting for a wait-and-see approach.

All this has helped the U.S. economy to revive from its late 2018 lows into posting impressive gains until U.S.-China trade issues emerged again last week. This recent turn of events has opened up a series of possibilities that could have a severe impact on the financial markets in days to come.

Trade Policy Uncertainties Could Rattle Markets Ahead

On May 13, China put retaliatory tariffs on $60 billion worth of American goods in a grim response to President Donald Trump’s decision to raise tariffs on $200 billion worth of annual Chinese imports from 10% to 25%.

The trade talks in Washington last week concluded without a deal and furthermore, the Trump administration is already getting ready to bring about $300 billion of more Chinese goods under the tariff umbrella. Once that is through, the United States would have imposed tariffs on nearly all products that Americans buy from China.

After all, the longer the trade war lingers, the more the economic activity in both countries will be hit. Both consumers and businesses in the United States and China have to absorb the price increases, which will ultimately weaken their spending and investments.

Alternative Mutual Funds Could Save the Day

Given the spectrum of the newest set of trade tensions and their ability to impact equity markets, it would be ideal to invest in alternative mutual funds which are known for their ability to hedge risks and provide steady returns in turbulent times. Such investments comprise long/short equity funds and market-neutral funds.

Long/short equity fundsare mutual funds that take long and short positions across a wide range of stocks and bonds. The fund managers seek overvalued and undervalued stocks which could be based domestically or abroad and across various market capitalizations. Overvalued stocks are shorted while undervalued stocks are purchased.

For example, if an investor buys a long/short mutual fund for $100, the fund manager will invest the amount in assets that are expected to perform well. For instance, if an investor shorts $40 in overvalued stocks, he receives $40 in cash, which can then be used to purchase more assets that are ideally undervalued stocks. Hence, the investor has $140 invested in long positions and $40 invested in short positions.

Market-Neutral Mutual Funds, on the other hand, long and short equal measures of their assets. This means that these hold half their assets and short the rest. This strategy identifies asset pairs that have related price movements. The fund buys the outperforming asset and shorts the underperformer.

For example, there are two companies that belong to a certain industry, for instance transportation. The fund manager takes long and short positions of equal amount of assets in both. Now, if transportation stocks fall, the fund manager loses because of the long position in the first company but gains because of his short position in the second.

Our Choices

We have selected three alternative mutual funds that carry a Zacks Mutual Fund Rank #1 (Strong Buy) or 2 (Buy). Moreover, these funds have encouraging three-year returns. Additionally, the minimum initial investment is within $5,000.

We expect these 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, but also on the likely future success of the fund.

The question here is: why should investors consider mutual funds? Reduced transaction costs and diversification of portfolio without several commission charges that are associated with stock purchases are primarily why one should be parking money in mutual funds (read more: Mutual Funds: Advantages, Disadvantages, and How They Make Investors Money).

Calamos Market Neutral Income Fund Class A (CVSIX Quick QuoteCVSIX - Free Report) aims for high current income that is consistent with capital preservation. The fund invests in equities and convertible securities of U.S. companies. It employs long and short selling and total return swaps to improve income and hedge against market risks. The fund may also invest in high yield fixed-income securities.

This Zacks sector – Market Neutral-Equity product has a history of positive total returns for more than 10 years. To see how this fund performed compared in its category, and other 1 and 2 Ranked Mutual Funds, please click here.

CVSIX has a Zacks Mutual Fund Rank #1. The fund has an annual expense ratio of 1.26%, which is below the category average of 2.11%. It has three-year returns of 4.4% and minimum initial investment of $2500.

Gateway Fund Class A Shares (GATEX Quick QuoteGATEX - Free Report) invests in a diverse portfolio of common stocks while also selling index call options and purchasing index put options. The fund aims for the majority of the returns that are associated with equity market investments.

This Zacks sector – Market Neutral-Equity product has a history of positive total returns for more than 10 years. To see how this fund performed compared in its category, and other 1 and 2 Ranked Mutual Funds, please click here.

GATEX has a Zacks Mutual Fund Rank #1. The fund has an annual expense ratio of 0.94%, which is below the category average of 1.42%. It has three-year returns of 5.5% and minimum initial investment of $2500.

Schwab Hedged Equity Fund aims for long-term capital appreciation that has lower volatility than the overall market. In order to achieve its investment objective, the fund takes long and short positions in equity securities issued by U.S. companies, where it invests the majority of its assets.

This Zacks sector – Long Short-Equity product has a history of positive total returns for more than 10 years. To see how this fund performed compared in its category, and other 1 and 2 Ranked Mutual Funds, please click here.

SWHEX has a Zacks Mutual Fund Rank #2. The fund has an annual expense ratio of 1.67%, which is below the category average of 2.18%. The product has three-year returns of 6.1%.  SWHEX doesn’t have any minimum initial investment.

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