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Market neutral funds focus on making very considered and thought out bets which tend to be based on a perceived pricing asymmetry whilst reducing the general market exposure through a variation of long and short positions. The ultimate goal is to be able to gain a beta as close to zero as possible to protect them against various risks.
Statistical and fundamental arbitrages are the two main market neutral trading strategies. Statistical arbitrage is based on finding the price anomalies in equities that will in turn ‘revert to the mean’ over time. By doing this the strategy aims to profit off the price convergence. Fundamental arbitrages view a company’s future path rather than using algorithms to invest in a particular stock that will eventually all meet at a certain price. In both situations, the bet equities are covered by a chain of long and short positions to avoid any market exposure.
There are some advantages to market neutral funds. One of the main advantages is that this strategy has a greater emphasis on hedging against market volatility. This has been considerably useful over the past few years when the market volatility previously hit unknown peaks. Whilst some hedge funds use other strategies and resulted in them experiencing significant losses during that period, most other neutral equities performed higher than the equity funds down to the emphasis on limited risk taking. Market neutral hedge fund mangers tend to place certain specialised bets on price convergence, avoiding exposure to general market risk. By doing this it causes the correlation between market performance and market neutral funds gain the second lowest positive correlation of investment strategies Hence why, the funds that invest in the hedge funds allocate a section of capital to market neutral funds. Their performance out does any other funds during the market loss periods. Another advantage to market neutral funds is that they are more resilient against to any sudden changes in liquidity due to the strategy’s balanced nature. This is not meaning to say that liquidity risk does not exist but that it plays a lesser factor than the other strategies.
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