Analizing market- neutral strategies
A market-neutral strategy is a type of investment strategy undertaken by an investor or an investment manager that seeks to profit from both increasing and decreasing prices in one or more markets, while attempting to completely avoid some specific form of market risk. Market-neutral strategies are often attained by taking matching long and short positions in different stocks to increase the return from making good stock selections and decreasing the return from broad market movements. The returns generated are unrelated to market swings and independent from actual price movements in stocks and bonds. One of the most important things to consider while employing market neutrality is specifying the kind of market risk to be mitigated.
There is no single accepted method of employing a market-neutral strategy. Beyond the method mentioned above, market-neutral strategists may also use other tools such as merger arbitrage, shorting sectors, and so on. A fundamental difference between long/short equity funds and market neutral strategies exists, even though they may be conflated quite often. Long/short equity funds focus on taking advantage of undervaluation or overvaluation across several industries by taking varying long and short stock exposures.
The latter, on the other hand, makes concentrated bets in order to hedge out any sort of systematic risk. So their main goal is to achieve a zero beta as opposed to the market index.
Understanding this, we can then learn about the main types of market-neutral strategies:
- Fundamental arbitrage: To project a given company’s share price trajectory and execute profitable trades based on the predictions, the investor used a fundamental analysis instead of quantitative algorithms. Fundamental analysis may include the overall financial health of the business, market conditions, competitors, etc.
- Statistical arbitrage: When a manager places trades on stocks based on quantitative methods, they use sophisticated algorithms to analyze historical data and expose price discrepancies in the given data. They then place their bets on stocks that are most likely to revert to their historical mean.
A great benefit and advantage of market-neutral funds is their big emphasis on constructing portfolios to mitigate market risk. In times of high market volatility, historical results have shown that market neutral funds are likely to outperform funds using other certain strategies.
Our arbitrage strategy in Quantia captures alpha without having exposure to the volatility of the market.
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