What are Market Neutral Strategies?
An investment strategy or portfolio is considered market-neutral if it seeks to entirely avoid some form of market risk, typically by hedging. A portfolio is truly market-neutral if it exhibits zero correlation with the unwanted source of risk. Obviously market neutrality is an ideal, but a portfolio which appears to be market-neutral may have unexpected correlations as market conditions change.
Investors and investment managers structure market neutral investment portfolios to profit from both increasing and decreasing prices in a single or numerous markets. Market-neutral strategies are often attained by taking matching long and short positions in different stocks to increase the return from making good stock selections and decreasing the return from broad market movements. Market neutral strategists may also use other tools such as merger arbitrage, shorting sectors, and so on.
Why You Care
Investors who can build a market-neutral portfolio are able to exploit any momentum in the market. One of the basic advantages hedge funds have over mutual funds is being able to buy long a stock as well as short a stock to create market neutral portfolios. Hedge funds commonly take a market-neutral position because they are focused on absolute as opposed to relative returns.
A market-neutral position may involve taking a 50% long, 50% short position in a particular industry, such as oil and gas, or taking the same position in the broader market.
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