Why 'market-neutral' fund label belies bewildering diversity

The term “market-neutral” may get thrown around a lot by fund providers promising consistent performance, no matter the prevailing conditions in the market. But a close look at the different strategies and performance numbers will likely give investors pause.

“[T]here is little uniformity among these products, and that is reflected in a disparity in their performance as well,” said a recent article published on the Wall Street Journal.

Citing the official definition from Morningstar, the article said market-neutral funds “attempt to eliminate the risks of the market by holding 50% of assets in long positions in stocks and 50% of assets in short positions.” Such funds are also characterized by P/E ratios and industry exposures that are kept the same for both long and short positions.

But many funds that adopt the “market-neutral” moniker deviate from that definition. Focusing on the U.S., the Journal said some funds like the BlackRock Global Long/Short Equity Institutional open-end fund (BDMIX) mainly seek to balance long and short strategies; others such as the IQ Merger Arbitrage ETF (MNA) follow a merger-arbitrage strategy, betting on which mergers will push through and capturing the spread between market and announced deal prices.

When the market was in the throes of volatility between Feb. 20 and April 30, BDMIX was reportedly down 1.04%, whereas MNA was down 4.87%

“The term market neutral is used extremely loosely,” Bill DeRoche, chief investment officer and head of AGFiQ Alternative Strategies at AGF Investments, told the Journal.

A scan of the 50 market-neutral mutual funds and ETFs documented by Morningstar reveals that during the period from February 20 to April 30 shows a wildly mixed bag of performance. The Hussman Strategic Growth mutual fund (HSGFX), which held a reported US$307 million in AUM as of July 1, notched a 12.57% gain, while the US$9.4-million Causeway Global Absolute Return Institutional mutual fund (CGAIX) logged a -16.5% return.

“There shouldn’t be this range of returns,” John C. Adams, an associate professor of finance and real estate at the University of Texas at Arlington, said to the Journal. Adams, who has published research criticizing the “market-neutral” label, said definitions for the term are “kind of all over the place” and that the period from February to April should have been their time to step up.

“It kind of goes with the idea that these are pretty actively managed,” he said. “And, on average, when you have a lot of active management, that performance tends to … go down.”

Follow WP on Facebook, LinkedIn and Twitter