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An investment strategy or portfolio is considered market-neutral if it seeks to avoid some form of market risk entirely, typically by hedging. To evaluate market neutrality requires specifying the risk to avoid. For example, convertible arbitrage attempts to fully hedge fluctuations in the price of the underlying common stock. A portfolio is truly market-neutral if it exhibits zero correlation with the unwanted source of risk. Equity Market Neutral Related Scholarly Compositions Market neutrality is an ideal, which is rarely possible in practice. Equity Market Neutral Hedge Fund Return Drivers A portfolio that appears market-neutral may exhibit unexpected correlations as market conditions change. The risk of this occurring is called basis risk.
The strategy holds long/short equity positions. Long positions are hedged with short positions in the same and related sectors so that the equity-market-neutral investor should be barely affected by sector-wide events. These positions, in essence, a bet that the long positions will outperform their sectors (or the short positions will underperform) regardless of the strength of the sectors. Equity-market-neutral strategy occupies a distinct place in the hedge fund landscape by exhibiting one of the lowest correlations with other alternative strategies.
Evaluating the Hedge Fund Research index returns for 28 different strategies from January 2005 to April 2009 showed that equity-market-neutral strategy had the second-lowest correlation with any of the other strategies, behind only short-bias funds which typically have a negative correlation with all other funds. This result is not surprising given that each fund utilizes the unique insights of a manager, and these insights are not replicated across funds.
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