• / Free eNewsletters & Magazine
  • / My Account
Home>Alternative Investments>Alternatives Investing>Category Overview: Market-Neutral Funds

Related Content

  1. Videos
  2. Articles
  1. Bogle on Fund Industry Progress and Imperfections

    The Vanguard founder offers his thoughts on the need for money fund reform, the dilemmas with retirement planning and savings, the fiduciary duty of fund managers, and much more, in this video exclusive to Premium Members.

  2. How to Plan for Your Retirement Time Horizon

    Financial expert Michael Kitces details the pros, cons, and trade-offs of common longevity-planning strategies as well as tips for how retirees can be realistic about their life expectancies.

  3. Special Report: Investing in a Volatile World

    Morningstar's top strategists discuss their tips for investing in a rising-rate environment, where equity values lie, and some of their favorite investment ideas right now in this special midyear roundtable.

  4. Housing: Long Term Strong, Short Term Sloppy

    The housing market has plenty of runway, but several headwinds will hold it back in the near term, says Morningstar's Bob Johnson.

Category Overview: Market-Neutral Funds

Low correlation is the appeal of market-neutral funds.

Philip Guziec, CFA, 07/19/2013

Market-neutral funds isolate return from a manager's skill by hedging out exposure to broad market movements. The remaining return comes from picking stocks long and short (equity-market neutral), selecting the most profitable merger deals, or seeking mispriced convertible securities. Just as the many long-only managers who struggle to add value relative to their benchmark, market-neutral funds endeavor to outperform their benchmark, which is typically cash. The average market-neutral equity fund returned 0.50% in the first half of 2013 and 0.20% in 2012, versus 0.05% and 0.08% for cash over the respective time periods. Further, the average fund in the category lost 1.0% over the past five years and generated only 0.8% over the past 10 years ending in June 2013, compared with 0.3% and 1.7% for cash, respectively. (Only nine of the 42 market-neutral funds had a 10-year track record, however.)

Despite the paltry returns of the category average, there are several standouts. The best performers over the past 10 years have been arbitrage strategies: Gabelli ABC AAA GABCX, Silver-rated Merger MERFX, Bronze-rated Arbitrage ARBFX, and Bronze-rated Calamos Market Neutral Income CVSIX turned in annualized returns of 4.6%, 3.7%, 3.7%, and 3.5%, respectively--well above the return of 1.7% for cash held over the same period. Gold-rated TFS Market Neutral TFSMX doesn't have a 10-year track record, but it returned 2.7% over the past five years by taking long and short positions in stocks based on nine different quantitative factor models, compared with 0.27% for cash.

Even modest returns can improve the risk-adjusted returns of a typical investor's portfolio, because of their low correlations. Over the five years ended June 2013, the market-neutral category has exhibited a correlation of 0.06 to the S&P 500 and 0.27 to the Barclays U.S. Aggregate Total Return Bond Index. As a result, investors added $2.1 billion to market-neutral funds in first five months of 2013.

Philip Guziec, CFA, is Morningstar's derivatives investing strategist. He leads Morningstar's OptionInvestor service, which applies Morningstar's fundamental research methodology and fair value estimates on 2,000 stocks to uncover option investing opportunities. Guziec joined Morningstar in 2003 after a career as an engineer and management consultant. Learn more about OptionInvestor.

©2017 Morningstar Advisor. All right reserved.