investment strategy In finance, an investment strategy is a set of rules, behaviors or procedures, designed to guide an investor's selection of an investment portfolio. Individuals have different profit objectives, and their individual skills make different tactics a ...

portfolio Portfolio may refer to: Objects * Portfolio (briefcase), a type of briefcase Collections * Portfolio (finance), a collection of assets held by an institution or a private individual * Artist's portfolio, a sample of an artist's work or a c ...

is considered market-neutral if it seeks to avoid some form of

market risk Market risk is the risk of losses in positions arising from movements in market variables like prices and volatility. There is no unique classification as each classification may refer to different aspects of market risk. Nevertheless, the most ...

entirely, typically by hedging. To evaluate market-neutrality requires specifying the risk to avoid. For example,

convertible arbitrage Convertible arbitrage is a market-neutral investment strategy often employed by hedge funds. It involves the simultaneous purchase of convertible securities and the short sale of the same issuer's common stock. The premise of the strategy is t ...

attempts to fully hedge fluctuations in the price of the underlying

common stock Common stock is a form of corporate equity ownership, a type of security. The terms voting share and ordinary share are also used frequently outside of the United States. They are known as equity shares or ordinary shares in the UK and other Comm ...

. A portfolio is truly market-neutral if it exhibits zero correlation with the unwanted source of risk. Market neutrality is an ideal, which is seldom possible in practice.Equity Market Neutral Hedge Fund Return Drivers
A portfolio that appears market-neutral may exhibit unexpected correlations as market conditions change. The risk of this occurring is called

basis risk Basis risk in finance is the risk associated with imperfect hedging due to the variables or characteristics that affect the difference between the futures contract and the underlying "cash" position. It arises because of the difference between th ...

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 Long/short equity is an investment strategy generally associated with hedge funds. It involves buying equities that are expected to increase in value and selling short equities that are expected to decrease in value. This is different from the r ...

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. These positions, 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 In statistics, correlation or dependence is any statistical relationship, whether causal or not, between two random variables or bivariate data. Although in the broadest sense, "correlation" may indicate any type of association, in statistics ...

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.

Examples of market-neutral strategies

Delta neutral In finance, delta neutral describes a portfolio of related financial securities, in which the portfolio value remains unchanged when small changes occur in the value of the underlying security. Such a portfolio typically contains options and their c ...

Pairs trade A pairs trade or pair trading is a market neutral trading strategy enabling traders to profit from virtually any market conditions: uptrend, downtrend, or sideways movement. This strategy is categorized as a statistical arbitrage and convergenc ...

References

{{DEFAULTSORT:Market Neutral Investment