Rationale behind a market neutral portfolio

Apologize in advance for the noob question, but for a long/short equity hedge fund, why do certain funds take market neutral positions? My understanding is that by shorting the industry or sector, you are eliminating systemic risk associated with the industry thus any outperformance will be a result of the stock itself.

But as stock pickers, what is the purpose of having 0 correlation to the market? Aside from eliminating risk, if you truly believe in your due diligence wouldn't hedging just take away from profits? I understand you can't be right 100% of the time as investors, but curious on the thoughts of industry professionals for their take.

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Comments (3)

Best Response
Mar 28, 2016

Think about it from the client's perspective. If you're a large institutional investor, you already have a strategic asset allocation, which includes allocations to equities. If you hire a "hedge fund" that has a long bias to equities, then you're actually getting more equity exposure than you've targeted. Moreover, if you invest in a manager with a long bias, you're paying alpha fees for a (partial) beta return. That's just throwing money away.

Good investors separate beta and alpha; and pay each accordingly (i.e. beta's less costly than alpha, because it's replicable).

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Mar 27, 2016

in theory, market neutral strategies can also make money in up and down markets. long biased strategies mostly cannot/do not

Mar 27, 2016