Jason Kephart: Market-neutral funds are long/short equity funds that aim to remove most, if not all, of their sensitivity to equity markets. They do this by making equally weighted bets on stocks the portfolio manager thinks will rise in value and those that will fall in value. The equal bets tend to give these strategies a volatility profile that's more akin to bonds than stocks. More conservative investors might consider using these funds as a substitute for a portion of their fixed-income exposure if they are concerned about rising interest rates and tight credit spreads.
Funds we like in the category take a variety of different approaches to stock-picking. AC Alternatives Market Neutral Value, for example, is based on fundamental research and focuses on inter-industry pair trades like long AT&T and short Verizon. Vanguard Market Neutral and BlackRock Global Long/Short Equity are both quantitatively driven and pick stocks based on factors. Vanguard Market Neutral focuses on more traditional factors like value and momentum, while BlackRock Global Long/Short Equity looks for more esoteric signals like internet search activity to forecast consumer sentiment. For investors that are balling on a budget, Vanguard is the cheapest of the three, while BlackRock is the most expensive.
It's important to remember that while these funds shouldn't be driven by the performance of traditional stocks and bonds they do carry risks of their own. Investors should make sure they understand those risks and are comfortable with them when choosing a market-neutral fund.