Market volatility over the past 12 months has created the perfect testing ground for market neutral funds, and the evidence suggests that some are passing the test.
Despite last August’s Black Monday, the January-February equity sell-off and Brexit, the average fund in Citywire’s 15-strong Alternative Ucits Market Neutral sector lost just 0.1% in the past year.
The market neutral investment strategy equally weights long and short exposures and generates returns when one side of the portfolio performs better than the other. The manager does not rely on the broader performance of the market, instead seeking to capture the outperformance or underperformance of certain stocks.
The ultimate goal is to reduce volatility and generate positive returns, regardless of market performance.
Topping the tables
The PTR-Agora fund’s sterling-denominated share class topped the sector, with a 22.6% return, achieved with a maximum drawdown of -3.6%. Managed by Pictet Asset Management’s Elif Aktug, Benoit Capiod and Vincent Ijaouane, the long/short fund invests in European equities.
Second spot goes to the MLIS Marshall Wace Tops Ucits Market Neutral fund, managed by Citywire AAA-rated Anthony Clake and Alan Hofmeyr. Over 12 months the duo returned 6.3% with a maximum drawdown of -1.2%. The fund has net market exposure between +15% and -15% across a global equity portfolio of up to 2,500 positions.
Citywire + rated Ian Heslop (pictured), whose Old Mutual Global Equity Absolute Return fund was in fifth spot, said: ‘We sit in a universe of funds that do lots of different things but are all called “absolute return”. These funds are heterogeneous in their approaches.’
Co-managed with + rated Mike Servent and Amadeo Alentorn, the fund seeks to achieve what Heslop describes as ‘pure market neutrality’ by using a long and short book of global equities to hedge one another. In the past year, the fund returned 2.5% with a maximum drawdown of -2.2%.
‘It’s not just about portfolio construction but also understanding how returns occur that don’t correlate with the market position. Our fund’s returns are different to equities, even though we use equities,’ Heslop said.
He said his fund could sit in a separate asset class to equities because it had a different return profile to long-only equity funds. It can also diversify equity risk and has done a good job of diversifying bond risk. In Heslop’s view, this is important in a market environment in which traditional correlations have broken down.
Hedge your bets
The managers have a blend of stocks in the portfolio. They try not to make big sector calls, instead looking at drivers for individual stocks.
Heybridge-based Grangewood Financial Management does not typically allocate new money to market neutral funds, as the firm generally follows a passive approach. But some clients have legacy positions in the Absolute Insight Equity Market Neutral fund, which the team is happy to continue holding.
‘We expect this fund to have low or negative correlation with other asset classes, providing diversification and risk control within portfolios. It offers steady returns over cash with limited downside and is part of the overall allocation to defensive assets,’ said the firm’s managing director, Allan Harragan.
Harragan remains positive about the different risk/return profile relative to other investments. ‘The disadvantages of absolute return funds are their relatively high cost and difficulty in estimating what future returns might be, which makes it a little more difficult for financial planning,’ he said.
Should you back market neutral funds in the future? Question marks remain over the effect of US monetary policy tightening, alongside the outcomes of the US election and Brexit vote. Further volatility seems likely: it could be time to hedge your bets.