Market neutral

Market neutral

An investment strategy or portfolio is considered market neutral if it seeks to entirely avoid some form of market risk, typically by hedging. In order to evaluate market neutrality, it is first necessary to specify the risk being avoided. For example, convertible arbitrage attempts to fully hedge fluctuations in the price of the underlying common stock.

A portfolio is truly market neutral if it exhibits zero correlation with the unwanted source of risk.[1] Market neutrality is an ideal, which is seldom possible in practice.[2] A portfolio which appears to be market neutral may exhibit unexpected correlations as market conditions change. The risk of this occurring is called basis risk.

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Equity market neutral

Equity market neutral is a hedge fund strategy that seeks to exploit investment opportunities unique to some specific group of stocks while maintaining a neutral exposure to broad groups of stocks defined, for example, by sector, industry, market capitalization, country, or region.

The strategy holds long/short equity positions, with long positions hedged with short positions in the same and related sectors, so that the equity market neutral investor should be little affected by sector-wide events. This places, in essence, a bet that the long positions will outperform their sectors (or the short positions will underperform) regardless of the strength of the sectors. Equity market neutral strategy occupies a distinct place in the hedge fund landscape by exhibiting one of the lowest correlations with other alternative strategies.

Evaluating the Hedge Fund Research index returns for 28 different strategies from January 2005 to April 2009 showed that equity market neutral strategy had the second lowest correlation with any of the other strategies, behind only short-bias funds that typically have a negative correlation with all other funds. This result is not surprising given that each fund utilizes the unique insights of a manager, and these insights are not replicated across funds[3].

Examples of market-neutral strategies

References

  1. ^ Equity Market Neutral Related Scholarly Compositions
  2. ^ Equity Market Neutral Hedge Fund Return Drivers
  3. ^ Opalesque (13 October 2009). "Back to basics with equity market neutral hedge funds". http://www.opalesque.com/55230/equity%20market%20neutral/Comment_Back_to_basics_with796.html. 
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References


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