Market-Neutral Strategy
AdvancedA market-neutral strategy is an investment approach that aims to generate returns regardless of the overall direction of the market, by balancing long and short positions to eliminate exposure to market movements.
A market-neutral fund typically holds long positions in investments expected to outperform and short positions of similar size in investments expected to underperform. The aim is for gains and losses from overall market movements to cancel out, so returns depend mainly on the relative performance of the investments chosen.
Some market-neutral funds aim for dollar neutrality, with equal values of long and short positions. Others aim for beta neutrality, adjusting position sizes so that the portfolio’s sensitivity to the market is close to zero. Many also try to neutralise exposure to sectors, regions and investment styles.
For example, a market-neutral fund might buy shares in one bank it expects to perform well and short an equal amount of shares in another bank it expects to perform poorly. If the banking sector falls, the fund can still profit if its chosen bank falls less than the other.
Market-neutral strategies aim for steady returns with low volatility and low correlation with markets. However, returns are often modest, and many funds use leverage to increase them, which adds risk. Unexpected market events can cause losses on both sides of the portfolio.
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