By: Matthew Kopsky - President HM Capital Management

Buy and sell – two words that will always come into the discussion when it comes to your investments.  But there are times when we need to add one more word: hold.  You might be able to accomplish this through a market neutral strategy.

Market neutral strategies have gotten a bad rap in the past, but that’s because they were associated with hedge funds. But let’s forget about that for a moment. A market neutral strategy can be defined as any investment strategy whose success is independent of systematic risk.  You can even say that market neutral strategies care about non-systematic factors.

Because traditional asset classes are tied into the business cycle, if the GDP starts failing, businesses earnings suffer and valuations decline.

Market neutral strategies operate independently of the market, so you don’t have to solely rely on long-only market behavior. Today there are numerous commodity traders who run market-neutral strategies who could care less if the GDP, equity markets and fixed income markets are rising or on vacation.

Let’s look at an example: say you’re invested in Apple Inc and Microsoft and you’re using a market neutral strategy. Let’s say you think Microsoft is going to do better than Apple in the future. You could take the long position in Microsoft and take a equal weight short position in APPL.  With a certain amount of money in the long position, but an equal amount in the short position, you have no net market exposure. But that’s okay.  

If Microsoft and Apple both went down 30% there would be almost no drop in your portfolio. Conversely, if they both went up 30% there would be virtually no change. This is because your long gain (or short) position is offset by your loss in the short (or long) position, thus creating a neutral market strategy!

If your original assumption was correct and Microsoft did do better going forward, it wouldn’t matter what happens to the market as long as Microsoft does better than Apple. Why…Because you’ll be making money because you went along with Microsoft and short with Apple.

So as long as the long does better than the short, you’ll make money in a market neutral strategy.

If these strategies can provide decent returns and low correlation to traditional asset classes, then they should be given some due diligence on your part for possible inclusion in portfolios.