From time to time, a really interesting fund will come to my attention. One such fund, the ETF Market Opportunity Fund (ETFOX), has chalked up some impressive returns over the last several years and appears ready to offer investors a rewarding and safe ride out of this recession. Better yet, the manager, Paul Frank, is a local boy living with his family in Old Chatham, New York.

Paul, 46, manages his $12 million fund from his colonial farmstead nestled beside one of the many roads of rural Columbia County. It hasn’t been easy for Paul but in May of this year he will have a five-year track record which will be the envy of many fund managers. His fund is already gaining attention.

For those who aren’t familiar with Exchange Traded Funds (ETFs) please see my column “Exchange Traded Funds have Come of Age. In brief, an ETF is an index fund that invests in a set number of stocks, bonds, currencies or commodities that mimic whatever index they target. Once established, they don’t change so an investor who buys a share receives approximately the same return as the underlying index. These securities have been around since 1993 and have been my investment of choice for more than 16 years.

Over the last few years a handful of managers around the country have created what are called Funds of Funds. These are mutual funds which invest in a portfolio of ETFs but their results have been spotty at best–except for ETFOX.

Over the last 14 months it has ranked in the top one percent of 1,800 large -cap growth funds measured by performance (the top 4% on a three -year basis). It is the only ETF fund that is rated highly (5 stars) by Morningstar, the premier mutual fund rating house, as well as by Lipper Fund Services where it is rated a Lipper Leader for Total Return and Preservation of assets.

Frank has a disciplined approach to investing and uses a combination of Modern Portfolio Theory principals and fundamental analysis in selecting from a universe of almost 200 exchange traded funds. Last year, although he was down, he still beat the benchmark S& P500 index by over 11% and by 3.5% over the last three years, and that’s after management fees.

So why did Frank decide on ETF investing rather than managing mutual funds or stocks? He explains that ETFs are cheaper with expense ratios less than half those of mutual funds. They also offer certain tax advantages for taxable portfolios. There’s another reason as well.

“By using ETFs I am taking security specific risk out of the equation. Investors will not be wiped out if a component of one of the ETFs suffers a loss.”

Frank uses a two prong approach to picking the best ETFs for his portfolio. He analyzes the risk versus return of each exchange traded fund and then uses good old common sense to decide if the numbers still make sense. If they do, he adds the ETF to his portfolio, but it’s no buy and hold strategy.

He monitors each investment constantly comparing it against both short and long term benchmarks and has no compunction in selling one of his funds, especially in this volatile market environment, if the investment goes the wrong way. He also uses inverse ETFs (funds that move up when the markets move down) to protect his portfolio when market conditions demand it.

The fund’s main theme is U.S. large cap-growth ETFs. However, between 20-25% of the fund is reserved for “opportunity areas”. In the first half of last year for example, Frank bought the Brazil Country Fund (EWZ) and a gold ETF (GLD) while in the second half he replaced those investments with two U.S. Treasury bond funds, clearly an astute move given the market’s performance. He admits that there were very few places to hide late last year, thus the bond investments. He also stayed away from the financial sector, picking defensive sectors like healthcare instead.

This year he has moved into biotechnology, high yield and corporate bonds, as well as some more aggressive investments but is still wary of the markets. You can see more by accessing his website at www.etfmutualfund.com.

So what kind of investor should consider adding this fund to their portfolio? Anyone who is seeking capital appreciation with longer than a one-year time horizon, since historically the fund has returned above-market returns while taking only 75% of the market’s risk. But buyers beware since the expense ratio is 2.22%, high for a fund management company, but given the performance of Frank’s fund it appears well worth the marginal expense.

Traditionally, investors run to cash or bonds, preferably Treasury bonds, when the stock markets decline. They exit, waiting on the sidelines, hoping to re-invest at the lows. Sadly, that strategy has proven to lose investors more money than if they had done nothing. Yet, no one wants to suffer the pain of watching their portfolios go down month after month. My advice is to hedge your investments in dire times like these with inverse exchange traded funds that protect your portfolio in downturns.

Exchange traded funds are index funds, which mean they invest in a set number of stocks, bonds, currencies or commodities that mimic whatever index they have targeted. If their underlying index goes up so does the fund and vice versa (for those unfamiliar with ETFs, please re-read my March column “Exchange Traded Funds have Come of Age” for further background on these securities).

An inverse ETF does the opposite; it goes up when the markets and sectors go down. Inverse or “short’ ETFs are available on various worldwide indexes including all the major ones here at home like the S&P 500, the Dow and NASDAQ. You can also hedge yourself with various sector and style funds. They are liquid, trade just like stocks and do not require large investments in order to hedge a portfolio.

Granted, you can accomplish this same purpose by the more traditional method of selling shares of stock short but that involves borrowing money and stock from your broker, establishing a margin account (similar to a loan), paying an interest charge for the privilege and receiving margin calls when the stocks you sold start to go up in price. Sound complicated, it is and successful short selling requires a great deal of chutzpah, skill and experience.

There are also put options and futures but they require you to open both future and options trading accounts. Besides, most brokerage firms will not allow investors to engage in such transactions unless they can furnish convincing proof that you the investor have the understanding and skill to engage in trading these instruments and understand the risks involved. With inverse securities you simply buy shares of an ETF when you are nervous about the markets or on a particular industry and sell your position when you think the coast is clear.

Let’s say you have a number of stocks and mutual funds in your $100,000 portfolio. You have spent a good deal of time and effort in putting these investments together. Along comes a year like 2008. All the sub-prime, credit and inflation problems have descended upon the market and battered your portfolio to the point that you just don’t want to take any more losses. But you hate to sell because you just know that the stocks you own will win out in the years ahead.

You could buy a few hundred shares of an inverse ETF, for example the Proshares Short S& P 500 (symbol: SH) for $67/share. Sure enough in the days ahead the S&P 500 declines by 5% while your investment in SH rises to $70.35/share. So what you might lose on your stock investments you gain on your short ETF. You can buy as many or as few as you like depending upon how much of your portfolio you want to hedge.

There are several families of funds that offer inverse ETFs such as Proshares, Powershares, Market Vector and more. Just Google the subject and explore the websites. You will discover that there are also leveraged inverse ETFs which double your inverse returns. These funds can accomplish this by using derivatives, futures and options. That means you can hedge your portfolios with just half the securities that you would need on a one-to-one ratio. That’s called leverage.

But let me give you a heads up on buying and selling inverse ETFs–don’t speculate. You can loose your blouse (or shirt) in this market if you start betting on market swings. There are some inverse ETFs that can move up or down 10% a day or more especially in several volatile markets like financials, oil, gold and currencies. Here you will be competing with the big boys, the hot money and they make a living picking off individual investors. Use these securities with the sole purpose of protecting your investments in stressful times.