Though President Trump’s support toward the extension of the debt limit deadline might have helped stocks book modest gains on Sep 6, a slew of headwinds will continue to spook investors in the month of September. Investors are expected to grapple with issues pertaining to North Korea. The rogue nations’ testing of its deadliest ballistic missile had sent shock waves through Wall Street, while drawing widespread rebuke from across the globe.

A potential catastrophic hurricane Irma and persistent worries about elevated stock valuations also raise concerns for investors. A record number of fund managers see the U.S. market as the most overvalued in the world. Among the 20 valuation metrics tracked by Ned Davis Research, 16 of them indicate that the U.S. stocks are extremely overvalued.

As if all this wasn’t enough, September is historically the worst month for the stock market. Weighing all the cons, alternative mutual funds seem to be the best way out for investors. Such funds are known for their potential to hedge risks, provide unwavering returns particularly in difficult times and a diversified portfolio.

What Are Alternative Mutual Funds?

These funds mostly include long/short equity funds, market-neutral funds and trading-leveraged equity funds. These types of funds are available to investors of all income groups. Let us now discuss the three types of funds in some details.

Long/Short Mutual Funds

Equity long/short funds seek to gain from both winning and losing stocks, irrespective of the market scenario. These funds use conventional methods to identify stocks that are either undervalued or overvalued. It profits from shorting the overvalued stocks and buying the undervalued ones. Weights are subject to change and are dependent on management’s view on the market.

For example: Say an investor buys a long/short mutual fund for $100, then the fund manager will invest it in assets that are expected to fare well. The manager shorts $30 in stocks that are believed to be overvalued. In the process, he receives $30 in cash. He will now use the $30 to buy more assets with an upside potential. Thus, now he has a total of $130 invested in long positions and $30 in short positions. This type of long/short fund is called a 130/30 mutual fund.

Market-Neutral Mutual Funds

Market-neutral funds aim to adopt a precision approach by shorting 50% of their assets and holding 50% long. This approach seeks to identify pairs of assets that have related price movements. The fund goes long on the outperforming asset and shorts the underperformer. For instance, you take a $1-million long position in Pfizer and a $1-million short position in Wyeth, both of which are large pharmaceutical companies. Now, if pharmaceutical stocks fall, you will lose because of your long position in Pfizer but will gain because of the short position in Wyeth.

A market-neutral fund is designed to provide stable returns at relatively lower levels of risk regardless of market direction. This is particularly relevant in today’s highly volatile scenario when the objective is to protect the capital invested.

Trading-Leveraged Equity Funds

Leveraged funds use borrowed money to increase returns in a short spell of time. These funds generally strive to return a certain multiple of the short-term returns of an equity index. For example, a 2X S&P 500 fund aims to generate twice the returns that the S&P 500 manages to achieve. Leveraged funds are primarily marked “ultra”, “bull” or “2X”.

Leveraged funds also offer benefits such as diversification. These funds invest in a diversified portfolio of assets which minimize risk, while escalating returns. In addition to this, investors enjoy the benefits of “dollar cost averaging,” where a young investor depositing $10,000 in these funds reaps the same benefits that a high net worth individual receives say by depositing $50,000,000. These funds also enjoy tax deductions.

3 Alternative Mutual Funds to Buy Now

The investment community is a dynamic one where new products will come into play and make the most of the stock market. In times of market uncertainty, alternative mutual funds are such new product classes that are equipped to protect investors’ portfolio and provide steady returns.

Here we have selected three such alternative mutual funds that boast a Zacks Mutual Fund Rank #1 (Strong Buy) or 2 (Buy), have positive 3-year and 5-year annualized returns and carry a low expense ratio.

Aberdeen Equity Long-Short A (MLSAX - Free Report) invests a large portion of its assets in long and short positions in equity securities of publicly traded companies in the United States. MLSAX’s 1-year and 5-year annualized returns are 7% and 3.9%, respectively. Annual expense ratio of 1.59% is below the category average of 1.91%. The fund has a Zacks Mutual Fund Rank #2.

Calamos Market Neutral Income A (CVSIX - Free Report) invests mainly in convertible securities and employs short selling to enhance income and hedge against market risk. CVSIX’s 1-year and 5-year annualized returns are 4.5% and 3.4%, respectively. Annual expense ratio of 1.08% is lower than the category average of 1.71%. The fund has a Zacks Mutual Fund Rank #1.

ProFunds Internet UltraSector Investor (INPIX - Free Report) seeks daily investment results, before fees and expenses that correspond to one and one-half times the daily performance of the Dow Jones Internet CompositeSM Index. INPIX’s 1-year and 5-year annualized returns are almost 40% and 31.2%, respectively.  Annual expense ratio of 1.5% is lower than the category average of 1.98%. The fund has a Zacks Mutual Fund Rank #1.