Marketneutral

Market neutral is an investment approach designed to achieve returns largely independent of broad market movements by balancing long and short positions to minimize net market exposure (beta). The goal is to produce positive, risk-adjusted returns through security selection rather than directional bets on market direction.

In practice, managers construct portfolios with long positions believed to be undervalued and short positions believed to be overvalued, aiming for a net exposure close to zero. Some strategies pursue dollar neutrality, where the value of longs equals the value of shorts, while others target beta neutrality by hedging against systematic factors. Leverage may be used to scale returns, but can amplify risk and costs.

Common implementations include long/short equity market neutral funds, pairs trading, dispersion trading, and certain forms of convertible arbitrage. Pairs trading seeks cointegrated securities with historically stable relationships, going long the stronger one and short the weaker. Convertible arbitrage exploits price distortions between convertibles and the underlying stock.

Risks include model risk, execution risk, borrow costs for shorting, liquidity constraints, and potential regime shifts when correlations change. Because market risk is largely hedged away, returns hinge on security-specific stock selection, which can suffer during volatile or illiquid periods.

Performance is evaluated using alpha and risk-adjusted metrics such as the Sharpe ratio; in efficient markets, market neutral funds may underperform directional strategies, while offering diversification and reduced beta exposure. The approach is commonly used by hedge funds and certain institutional investors seeking non-directional exposure.