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The market neutral strategies involve ways to avoid market risks i.e. gain during rise or fall of stocks. The various strategies where one will gain, even in conditions, when the stocks fall are market neutral strategies, which can involve merger arbitrage, convertible arbitrage, relative value arbitrage and equity market neutral. Such strategies are sorted by portfolio manager on zero beta strategy where the average moves independently of the market.
Pair trade helps in implementing market neutral strategy where the main idea was to assume that all the stocks will outperform the other, and the trader sells or buys equities of same sector, at one time. The trader continuously makes high conviction pair trade where the trades are made simultaneously to prevent a risk. The portfolio manager can identify the positive and negative beta funds, and combine them in proper ratio to get zero-beta.
Sometimes, a mixture of such strategies can become risky. In the last decade, the concept of The Qunat Quake, where products of too much leverage were used, overcrowded the market. The strategy of market neutral can be deployed in developed and emerging markets, and the sub strategies can be dollar based, sector neutral or beta. Leverage can help to amplify spread and these are driven by alpha or style factors such as quality, momentum or value. The market neutral strategies should involve diversification and neutrality.
Equity market neutral
Initially, the strategy was created in 1949 with long short play, and was believed to be risky where combined techniques were used for delivering conservative results. Properly designed equity market neutrals could help in stabilizing the portfolio.
Equity market neutral or EMN strategies are mostly advised as capital preservation strategy where losses are low even in the worst scenario. These are widely used by financial institutions, foundations, funds and individual investors because, in case, the market falls, the bonds and cash will not provide protection against loss, while, strategy such as EMN can prevent such loss. This mechanism works as a stabilizer. The strategy should involve markets and factor neutrality where the component such as long term / short term and value added can be used. Sometimes, the funds make use of alternatives such as spread betting or other methods for shorting, and anomalies in the selection of instrument and stocks can be, sometimes, be affected by the investor’s personal preference, demand supply, indexation, behavioural bias, government regulations etc.
Market neutral strategies
Most of these include hundreds, or, thousands of stocks, long and shorts, and target high turnover, changing the strategies as the market trends change. Sophisticated technologies are used which contains risk modelling, stock selection model, transaction based model and optimization techniques. The main aim is to diversify and neutralise factors. The managers of these funds include a number of sub strategies such as themes, values, liquidity, momentum and other complex methods to which are clustered together to get the desired output. The factors are identified and developed into alpha generating modules where inputs from leading market magazines and websites are taken. Along with statistical research, studies are devoted to identify new and effective methods.
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