There’s no denying that broader equity gauges are performing well this year. There are also clear signs of life in the fixed income arena following a dismal 2022. Still, the current environment isn’t completely sanguine, as market participants continue expressing concerns about the macroeconomic outlook.
For example, inflation data remains elevated. Couple that with strong jobs growth, and the Federal Reserve may have no choice but to raise interest rates again later this year. Conversely, GDP growth is slack, and other economic indicators suggest that a recession is still possible.
One way of looking at that scenario is that now is an ideal time for investors to consider strategies that reduce risk and reduce correlations to traditional asset classes, such as bonds and equities. Market-neutral investing accomplishes those goals.
Market-neutral investing is accessible in fund form, including with exchange traded funds. A simple definition of this methodology is that a market-neutral fund should be able to generate decent returns when stocks are moving higher and provide protection, if not modest upside, when equities falter.
Market-Neutral Is Increasingly Appealing
Like any other investing style, market-neutral isn’t foolproof, and it’s not a guarantee of noteworthy returns. However, it holds appeal as an avenue for reducing portfolio correlations — something that should not be overlooked.
“As the name suggests, market neutral strategies are designed to target returns that are independent of market direction. Compared to active long-only strategies that invest only in the highest conviction stocks and avoid those with a less favorable outlook, market neutral strategies are able to make both long and short investments,” according to BlackRock research.
When operated effectively, market-neutral ETFs essentially combine long and short positions to deliver market exposure of zero to end users. By accomplishing that, market-neutral fund performance isn’t determined by broader market gyrations.
Rather, it largely boils down to security selection. As such, many market-neutral strategies are actively managed. This means that fund managers’ acumen at identifying long and short positions is the primary determinant of investor outcomes. To the point, dispersion between the fund’s long and short holdings drives results.
“As the previous ‘rising tide lifts all boats’ environment appears to have come to an end, the opportunity to take advantage of the relative return differences across securities makes a market neutral approach increasingly compelling,” added BlackRock.
Market-neutral ETFs have gained traction with advisors and investors. Several members of this category have north of $1 billion in assets under management, and many more have at least $100 million.
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