Market-neutral investing is one way to attempt to take advantage of both bear and bull markets. Therefore, Utilizing this strategy on your own is certainly possible, but challenging. There are market-neutral mutual funds that will employ a market-neutral investing strategy for you. Moreover, this can save a lot of time and energy.
Market-neutral funds are aggressive and complex. Nonetheless, If you’re an entry-level investor or invest conservatively, this type of fund might not be for you. If you’re sold on utilizing a market-neutral strategy, but lack the time or expertise, a market-neutral fund might be the answer.
These funds seek to provide a return beyond the performance of the market without correlating with the performance of the market. The results are intended to be independent of the market. This is not a guarantee of beating the market, however.
Understanding market-neutral funds:
1. Market-neutral funds combine both short and long positions in a variety of securities. The portfolio can include stocks, bonds, currencies, and other investments. Like a hedge fund, there are few self-imposed limitations on market-neutral funds. Be sure to read the prospectus to find all the information you need.
2. The fund manager researches investments and creates two lists. One list is securities he expects to outperform the market. The other list is comprised of securities he expects will underperform. The ability to build these lists accurately is the most important component of success.
- The value of the short and long investments should be equal. In other 1words, an equal amount of money is invested in short and long positions. There are other types of funds that also utilize a long and short strategy, but the ratios heavily favor long positions.
- The portfolio is regularly adjusted to maintain a one-to-one ratio of long and short investments. These regular adjustments add to the costs of operating the fund.
3. Management fees are quite high. Typical fees are in the 2-3% range. This is higher than most other managed mutual funds and much higher than index funds. Many experts compare market-neutral funds to hedge funds. In that case, the costs are low. It depends on your perspective.
- It’s important to realize that the higher fees detract from your final returns. The instance of a 3% fee reduces the 12% return to 9%. This is a significant hurdle to overcome.
4. The transactional expenses are also high, further reducing returns. While conventional mutual funds might hold a stock for decades, market-neutral funds might only hold a security for a few days.
- This rapid turnover creates additional transactional expenses. The regular rebalancing found in market-neutral funds further contributes to the transactional expenses.
5. The short positions further add to the costs. Short positions require the borrowing of securities or providing collateral. This collateral is often provided via margin accounts. All of this borrowing is an additional expense.
6. There’s no guarantee of positive results. While many market-neutral funds have done well over the years, many others have not.
- As with other types of funds, the skill of the manager is important. If she chooses the securities wisely, the returns can be impressive. No strategy will overcome poor investment selection. Research your fund manager.
The skill of the fund manager and the specific strategy followed to determine the performance of market-neutral funds. Market-neutral funds can reduce the amount of work and expertise required to follow a similar strategy on your own. As with any investment, it’s always valuable to do your research and reach your own conclusions.