Market-neutral and long/short funds, like hedge funds, attempt to generate absolute returns regardless of how the broader market performs. That’s achieved by holding a combination of long and short positions in its portfolio. With a long-dollar to short-dollar ratio of 148 percent, TFS Market Neutral (TFSMX) is a long/short fund that attempts to live up to its name and limit its correlation to the S&P 500.

And that strategy has paid off handsomely. Ranked in the top of its category in 2007 by Lipper and appearing in “The Rukeyser 100” for several months running, it ranks in the top 2 percent of its category for a three-year annualized return of 7.91 percent. And that’s compared to an 8.24 percent loss for the S&P 500.

That performance isn’t a fluke. The fund has returned 9.25 percent since its inception in 2004, versus a 5.27 percent loss for the S&P 500 over the same time period. It’s also beaten the index by at least a percentage point each year since its inception.

Most market-neutral funds attempt to offset long positions with short positions, aiming to maintain a low correlation with their stated benchmark. The fund has performed admirably well in that regard with a beta of only 0.26 compared to the S&P 500 during the market crisis and 0.25 percent since its inception.

But market-neutral funds aren’t for everyone. For starters, expenses for these types of funds tend to run fairly high, and TFS Market Neutral is no exception with an expense ratio of 2.49 percent. That’s largely because of frequent trading and a large management staff.

With an annual turnover rate of 204 percent, tax efficiency is an issue; if you’re worried about capital gains, this fund isn’t for you.

Finally, the term “market neutral” may be a bit of a misnomer; don’t be fooled into thinking there’s no risk involved. Market-neutral funds seek to minimize their correlation with the broader markets, not totally eliminate risk–a fool’s errand.

One legitimate point of contention is that the fund has maintained a slightly long-heavy portfolio, which most market-neutral funds try to avoid. Management allocated $1 to short positions for every $1.50 in long positions.

Some critics also find fault with management’s lack of experience, but those concerns are overblown; TFS runs two hedge funds using the same strategies. And over the past three years, management has definitively shown that it can thrive in both bull and bear markets. True, there has been some quarter-to-quarter volatility in returns, but that smoothes out over time and annual returns have always been positive. In fact, the fund’s worst year was 2005, when it gained just 5.9 percent.

And management apparently believes in its strategy, investing 75 percent of the firm’s liquid assets into the fund. That creates a vested interest on their part to consistently generate respectable returns and closely aligns their interests with those of shareholders.

TFS has announced that effective June 30, the fund will close to new investors after its performance attracted a raft of new investors. Because the data we use to compile “The Rukeyser 100” lags by one month, the fund will drop from the table in August.

But that doesn’t mean you should sell your holdings. This continues to be one of the few funds we like in this category, and we appreciate management’s efforts to limit asset bloat. Investors who currently own shares shouldn’t cash out, assuming the fund remains consistent with his or her investment strategy.