Some might offer the funds themselves, others in conjunction with mutual fund companies.
Such mutual funds are possible because of recent tax law changes that were part of the Taxpayer Relief Act of 1997 signed by President Clinton last month.
The new law repeals the "short-short" rule, which barred mutual funds from deriving more than 30% of their gross annual income from the sale of securities held for less than three months. Funds that tripped could lose their tax-favored status for the year, and be taxed as corporations.
Strategies include "market neutral" or "long/short," which aim to generate returns unconnected to movements in the stock and bond markets.
Such strategies rely on the portfolio manager's skills in shorting stocks of laggard companies, as well as in buying stocks of companies expected to beat the market.
The changes also could spark greater interest in shorting outside of the strategy, as well as in derivative-based investment strategies. And foreign stock funds would be able to better hedge their foreign currency exposure.
The repeal of the rule also could result in greater portfolio turnover while allowing managers to seek higher returns.
This would be true especially for any new funds, which may profit from securities held for only a few months. Until now, new funds, especially those started toward the end of a fiscal year, could not offload any of their investments in the last three months, because they would run afoul of the rule.
"I suspect there will be various strategies and different types of funds that will be put forth" as a result of the rule being lifted, said Larry Friend, chief accountant in the Securities and Exchange Commission's investment management division, which regulates mutual funds.
The interest in market neutral or long/short funds comes as many observers expect to see the market lose some of its punch. In its simplest form, the market neutral strategy often lags in a red hot market, but offers investors downside protection in a free fall.
Numeric Investors, Boston, with $3.6 billion in assets, is "definitely" considering offering a mutual fund sometime next year based on a market neutral strategy, said John C. Bogle Jr., managing director.
"We have spoken to fund counsel and they seem to agree that from a regulatory standpoint, there is no reason we can't do it," Mr. Bogle said.
The more pertinent question, he said, is whether there is enough liquidity in the market to allow Numeric to offer such a fund - in a large-cap value style - and still earn attractive returns.
First Quadrant, Pasadena, Calif., held discussions earlier this year with two mutual fund companies to manage market neutral funds as a subadviser, but abandoned those talks "when it became clear it wouldn't get done for regulatory reasons," said Christopher Luck, director of equity management.
Mr. Luck said he intends to resume those talks now that the short-short rule has been repealed. He would not name the companies.
Zacks Investment Management, Chicago, which manages $80 million in a long/short strategy for institutional investors, has had "preliminary" talks with New England Investment Cos., Boston, about starting a market neutral mutual fund, said Leonard Zacks, director of research.
"The short-short rule was one of the problems. Now that has gone away," he said.
The Quantitative Group of Funds, Lincoln, Mass., with about $200 million under management, also is "looking into" setting up a market neutral fund, said Edward L. Pittman, president.
The repeal, he said, "is going to allow people to use higher turnover strategies and more momentum strategies. There may be a tendency for some funds to move the dial from 'gentle wash' further toward the spin cycle as they seek to enhance returns."
Until now, the firm frequently had to shut down trading "because we'd have to hang on to things even though we would rather sell them," Mr. Pittman explained.
The Rydex Series Trust, Rockville, Md., also is considering new funds and new investment strategies that would extend the firm's current offering of indexed funds. Skip Biragh, president, said company executives will have a better idea of what those might be in about a year's time.
The short-short rule, enacted as part of the Revenue Act of 1936, was designed to prevent speculation, and churning or constant buying and selling of stocks by portfolio managers to generate commissions. But, former SEC Chairman Richard C. Breeden told lawmakers in 1991 that the rule had outlived its usefulness because other securities laws put in place since the 1930s act as deterrents to churning and speculative investing.
Some industry experts warn the short-short rule was just one of many regulatory roadblocks slowing the development of new mutual fund strategies. Securities rules, for example, still limit the extent of shorting or borrowing a fund can engage in, and each short sale must be covered by assets set aside whose market value is sufficient to satisfy the fund's obligations.
There's also the question of educating investors.
After all, "most investors don't consider short selling as an investment strategy," pointed out David Mangefrida, partner in the Washington office of Ernst & Young, who specializes in mutual fund taxation issues.
Still, Mr. Mangefrida believes the lifting of the rule will stimulate the creative juices at small, niche-type mutual fund firms looking to exploit new areas, as well as at behemoths offering a full array of funds.
"Certain funds that are more aggressive will move into the marketplace over the next few years. But it won't happen over the next few months," he said.