The hedge-fund club isn't as exclusive as it once was, thanks to the burgeoning ranks of mutual funds that emulate hedging strategies at a more palatable price. And that's good news for investors who can't stomach stock-market dives, no matter how brief they are. These funds were put to the test during the market's late-winter rout, and most barely broke a sweat.

The strategies of hedge-fund-like mutual funds vary, but their basic mission is to try to defend against market declines and still deliver decent returns. If implemented effectively, hedging strategies can produce steady returns that move out of step with the stock and bond markets. As part of a larger portfolio, hedge-like funds can serve as powerful diversifiers that reduce your overall risk. But financial planners don't recommend that they be your core holding -- at most, they should make up 15% to 20% of your investments, depending on your tolerance for risk.

Hedge-like mutual funds cost much less than traditional hedge funds, which charge 2% of assets per year, plus a 20% cut of profits. That's not to say that hedge-like funds are cheap. The average annual expense ratio for these mutual funds is 2.25% (by comparison, the average expense ratio for diversified U.S. stock funds is 1.38%).

The long and short of it

Some funds employ a popular approach known as a long-short strategy. Such funds buy stocks the old-fashioned way, but they also sell some stocks short in an attempt to make money when those stocks sink. Combining "longs" with "shorts" tends to stabilize returns, making the funds far less volatile than the overall stock market.

How stable a long-short fund is depends on the relative weight of long versus short positions. Schwab Hedged Equity, which uses computers to pick which stocks to short and which to buy, is biased on the long side. When the fund's managers are bullish on the market, they sell fewer stocks short; when they're more pessimistic, their allocation to shorts grows (the fund is currently 35% short).

Over the long run, the fund aims to beat Standard & Poor's 500-stock index with a fraction of the index's volatility. By and large, it has been successful. From the inception of the Schwab fund's oldest share class, Select, in September 2002 to April 2, it returned an annualized 13%, the same as the S&P 500. The fund's retail class (symbol SWHIX), with a $2,500 minimum initial investment, launched in 2005. But Hedged Equity was about 40% less volatile than the index. "The return is similar, but the path we took was different," says Vivienne Hsu, one of the fund's managers.

A more flexible variation of the long-short theme plays out in Hussman Strategic Growth (HSGFX). Manager John Hussman invests in companies of all sizes, but he can hedge some or all of his holdings depending on his assessment of market conditions. He does so by offsetting the fund's long holdings with options that allow him to bet against the S&P 500 and the small-company Russell 2000 index. On the flip side, he can ditch the hedges or even use leverage to juice returns if he's high on stocks.

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