Investors want to know if both bonds and stocks are overpriced (thanks to the Federal Reserve’s Quantitative Easing) and thus due for a crash then what, besides putting cash into a mattress, should they do with their money.

One new asset class, which is really more of a strategy than an asset class, is Long-Short Credit strategies funds. Investors have asked me can Long — Short Credit Strategy funds beat the market? The funds buy long term high yielding bonds and then short sell some bonds so they remove or reduce the duration risk (interest rate risk) of long term fixed rate bonds. During the past 12 month period ending 8-12-13 when the 10 year Treasury went from a low of 1.56% on 8-31-12 to 8-12-13 when it reached 2.72% the huge increase in interest rates made the 20+ year Treasury ETF TLT (it has an 16.7 year duration) drop 15% in price and the Barclays Aggregate (with 5 year duration) dropped 5% in price. By contrast, three hedge-like funds one had a 2% appreciation with a 1.5% distribution yield; another had a 3% appreciation with a 4.5% distribution yield; a third had a negative 1% price return and a 5.7% distribution yield.

Of course stocks went up a lot in the past 12 months. Small cap stocks went up 35% in 12 months which is a clear sign of a bubble. That is precisely why it is a bad time to own stocks.

To pick a long — short hedge-like fund investors should seek independent financial advice which is best gotten from a fee-only financial advisor. Also these funds are best purchased through the institutional channel of a Broker and gaining access to that is through a Registered Investment Advisor. The advisor should offer a portfolio of different funds and not put all of the client’s money into one basket.

These funds are not risk free. In order for Long — Short Credit Strategy funds to beat the market they depend on the manager to buy Put options on bonds, short-sell futures contracts on bonds, take a long position on bonds, etc. There is no guarantee that a strategy will work as planned. Investors should realize their subconscious mind may make them think the word “bond” means a risk-free Treasury or a very low risk corporate bond rated AAA. However, hedge-like bond funds hold many risky “B” paper below investment grade bonds.

Then there is the risk that the manger could be too clever and shoot himself in the foot. For example the manager could short-sell long term bonds to protect from rising rates only to find that some foreign country decided to buy more Treasuries during an international financial panic, thus driving down Treasury interest rates and increasing Treasury bond prices. China, the European Central Bank and Japan all have to deal with a lot of hidden risk and they may decide to print more of their own money and sell it to buy U.S. Treasuries. This would devalue their currencies, stimulate their economies and reduce U.S. competitiveness.

There are several bond mutual funds that offer the credit strategies long-short asset class in reasonable investment amounts. The so called “credit strategies” or long-short credit assets may be an opportunity to get better results than simply meekly investing in short term bonds as some people did in the 1970’s.

These strategies work by doing things like short selling long term bonds to take out the risk of rising interest rates, then going long on bonds from favored industries and buying CDS contracts (a Put option on bonds) on industries that are expected to become weaker. That way whatever happens to interest rates the mutual fund is “market neutral” and seeks to profit from the improvement in credit quality in one industry and the degradation of credit quality in another industry. This is an excellent way to cope with an era of rising rates. Other techniques include cherry picking defaulted mortgages in hopes that they will suddenly improve in credit quality. This is somewhat like a speculator who “flips” a foreclosed house except the loan is flipped instead of the house. Some banks and investors are required by their charter or regulator to panic sell their way out of a position in defaulted debt and the buyers of that used to be hedge funds but now mutual funds are getting into buying those assets. Of course these mutual fund managers are human, and as such they could be wrong, so investors should invest in different asset classes besides “credit strategies” and keep their expectations in check instead of seeking a windfall.

If the economy is fated to have QE end and have the end of QE prick the stock market bubble and also hurt long term bonds then it is good to know that there may be other assets to own besides cash. The dilemma that investors face (where both long term bonds and stocks are overpriced) is reminding me of the inflationary 1970’s where nothing except short term bonds worked. However, what is different is that inflation during the post QE era will be very reasonable and now the investment world offers alternative assets such as long-short credit strategies. These long-short credit opportunities didn’t exist in the 1970’s.