(FORTUNE Magazine) – Take a stroll along New York's Canal Street, and you'll soon discover that you've arrived in knockoff heaven: Here a "Gucci" bag can go for $20, a "Rolex" watch for even less. Well, now it seems that Canal Street is even intersecting Wall Street. In what may be the most platinum of perks to go copycat, the mutual fund industry is bringing the elite hedge fund down to subway level.

For as little as $1,500, investors can buy into the same kind of fund that usually costs $1 million and employs virtually every risky technique in the book to make money. Hedge fund managers will short stocks (by selling borrowed stocks they expect will drop), a technique that can result in infinite losses. They'll borrow money against the portfolio to buy more stocks (also known as leveraging), a tactic that can significantly enhance returns--and greatly exacerbate mistakes. They'll also engage in the use of exotic derivatives (remember Long-Term Capital?). All that excitement in a mutual fund? Well, almost.

Just like designer knockoffs, there are some differences between these new "hedged mutual funds" and the real thing--the most significant of which is that the SEC limits the degree of short-selling and leveraging that can take place within hedged mutual funds (to half and a third of the funds' assets, respectively). Still, there's no question that the middle-class version offers investors a far greater variety of volatility-fighting tools than ordinary mutual funds do--tools that may not have been missed during the white-hot market of 1999 but which could potentially make all the difference in these skittish times.

"In an up market we tend to slightly underperform, but in a down market we way outperform," says Peter Trapp, portfolio manager of the Needham Growth fund, which posted a 7.4% return in 2000 (when the average mutual fund return was a scant 0.6%). It's up 8% so far this year. Trapp says the fund's willingness to short stocks whenever necessary "is key"--he's currently short on retailers and contract manufacturers. He's also sitting on a lot of cash--more than 10% of the portfolio--in order to take advantage of opportunities in the beaten-down tech sector. "I feel like a kid in a candy store," he says. But Trapp says he'll be ready to switch gears again if the tech-heavy Nasdaq suddenly rallies. "If we were to get a bounce back to 2,500, by that time we'd probably be pretty short."

Over at the Invesco Advantage fund, manager Tom Samuelson is not only shorting stocks but also using derivatives to goose returns. The strategy has generated mixed results so far--after its inception in August 2000, the fund shot up 13% in a decidedly ugly market, but it has since lost ground. Still, Samuelson believes that his ability to leverage the fund will help him outperform in a bull market--a theory that has yet to be tested.

In fact, it's precisely the lack of any long-term track record that makes some observers wary of hedged mutual funds. "It's a space I wouldn't want to devote much money to," says Russ Kinnel, director of fund analysis at Chicago fund-tracking firm Morningstar. Kinnel also warns that tactics such as short-selling could easily create more, not less, volatility for investors. Certainly investors in the Montgomery Global Long-Short fund have had a rough enough ride. After racking up impressive returns in 1998 and 1999, the fund stumbled in 2000, losing 24% after the fund's managers made an ill-timed reentry into the tech sector during the fourth quarter. And that leads to another important consideration for investors: Win or lose, these funds usually charge higher fees than traditional mutual funds, adding to the risk factor. What's more, the strategies employed by hedged mutual fund managers can vary wildly. Careful study of the plan's prospectus is a course requirement.

That being said, some bolder (and less risk-exposed) investors may find the right hedge a good edge going forward--for a very modest portion of their assets at least. Marcel Engenheiro, president of Gemini Funds, which launched its Gemini Global New Economy fund in December, says investors should take comfort in the fact that more than a third of his fund's assets were kicked in by the managers themselves--thus creating a powerful incentive to perform. "You've got to eat your own cooking," he insists. (In this case, unfortunately, it's lean cuisine: The fund is down 1.7% year to date.) Engenheiro, however, remains confident that the use of short-selling, leveraging, and derivatives will enable it to outperform conventional mutual funds. "We're not just another can of tuna on the shelf," he says.

No argument there.