Diversity is a mainstay in our industry. We search for it, sell it to clients, and ultimately rely on it in seasons of market uncertainty. Understanding the importance of insulating portfolios from total market vulnerability is simple. Staying up-to-date on available strategies to dampen the effects of volatility can be tricky.
In 2016, select Market Neutral strategies served as a unique diversifier strategy that many likely overlooked. Could Market Neutral be the long-sought diversity piece to your client’s portfolio?
What is a Market Neutral Strategy?
Market Neutral is a hedge fund strategy that seeks to exploit difference in stock prices by being long and short in stocks within the same sector, industry, market capitalization, or country – as defined by Investopedia. It is a diversification strategy that creates a hedge against market factors, minimizing market movement influences with strategic stock selections and other tools, such as merger arbitrage and shorting sectors.
Successful Market Neutral Strategies
When we think of the major mutual fund complexes it is fair to say that while both large and incredibly successful, it would be difficult to imagine two firms more dissimilar than Vanguard and AQR. Vanguard front man, John Bogle, the icon of index, believes “99% of trading is pointless”. In contrast, AQR chairman, Cliff Asness is revered as one of the great traders of his generation.
What do these diverse power house investment firms have in common?
Both firms currently offer what we believe to be the premier Market Neutral strategies available to individual investors. In 2016, Vanguard Market Neutral returned a solid 2.62% and AQR Equity Market Neutral closed at 5.43%. Vanguard and AQR also led the industry in positive inflows of actively managed assets – a feat achieved by few among the growing indexing craze. Vanguard topped the charts with $20.37 billion in 2016, followed by AQR’s $10.39 billion(MorningStar Direct Asset Inflows).
Both strategies take a beta neutral approach to long short investing and provide FTJ FundChoice Advisors with strategies designed perfectly for the third mandate of our Market Movement Strategies (MMS) platform. As of their most recent reporting both strategies have a slightly higher number of longs than shorts, but both are adhering to their stated goal of profiting from stock selection rather than from general market movements.
AQR states that “the portfolio is designed for absolute returns and to generate positive returns regardless of market cycle.” This is not uncommon language for this firm as many of their strategies are designed primarily for low correlation to traditional markets and may trade in exotic asset classes relying on the firm’s lauded capability to create alpha.
Vanguard’s material warns investors, “This fund has a unique and complex investment approach, compared with other Vanguard funds. Its goal is to “neutralize,” or limit, the effect of stock market movement on returns. Because of this, the fund’s return is often uncorrelated to that of the stock market. Unlike other Vanguard funds, this fund uses long- and short-selling strategies, which involve specific risks not apparent in traditional mutual funds. The fund may be appropriate for a small portion of an already well-diversified portfolio.”
Mr. Bogle is clearly not a huge fan, but we are. Rocaton Advisors selected both strategies as Diversifiers to be featured on our investment platform. Neither has disappointed.
The lesson here is that great strategies may be uncovered in surprising places. We believe that we are in an era of great diversifier opportunity, and that even though traditional stock and bond markets could be primed for a breather, strategies not relying on Market Movement are being prioritized by top-tier investment firms of every kind.
The information, analysis, and opinions expressed herein are for general and educational purposes only. Nothing contained in this commentary is intended to constitute legal, tax, accounting, securities, or investment advice, nor an opinion regarding the appropriateness of any investment, nor a solicitation of any type. All investments carry a certain risk, and there is no assurance that an investment will provide positive performance over any period of time. An investor may experience loss of principal. Investment decisions should always be made based on the investor’s specific financial needs and objectives, goals, time horizon, and risk tolerance. The asset classes and/or investment strategies described may not be suitable for all investors and investors should consult with an investment advisor to determine the appropriate investment strategy. FTJ FundChoice does not guarantee any minimum level of investment performance or success of any index portfolio or investment strategy. Past performance is not indicative of future results. Information obtained from third party sources are believed to be reliable but not guaranteed. FTJ FundChoice makes no representation regarding the accuracy or completeness of information provided herein. All opinions and views constitute our judgments as of the date of writing and are subject to change at any time without notice.