What are Market Neutral Funds?

We all read the statement that mutual fund investments are subject to market risks which means market fluctuations can impact the returns expected from mutual funds. But there is a solution to this volatility: Market Neutral Funds. Market neutral funds stay neutral and hedge the risk of such fluctuations even if the market increases or decreases. Let’s go deep!

What is Market Neutral?

Market neutral refers to an investment strategy or portfolio to avoid some market risk entirely, typically by hedging. Here an investor gains from either an increase or a decrease in stock prices. Market-neutral funds create their proprietary investment strategies. It is usually done to avoid given market risk and may be applied in one or more markets. However, it can be complicated to identify the market factors that will impact their performance.

What is a Neutral Market Position?

A neutral market position is a fifty-fifty hedge in either direction, i.e., long or short position. A market-neutral fund generates returns by combining long and short positions in various securities.

What does it mean by long or short position?

Either direction essentially means a “long” or “short” position. A long position is gained by purchasing the securities expected to increase in value and then selling them at prevailing market value. Conversely, a short position is achieved by selling security expected to decrease in value and then buying it at such value. The differential value in each position is the profit earned by the investors.

Factors to consider before making Investments

Risk- Reward factor: The risk-reward status need to be considered here. The market-neutral funds do not solely depend on the fund’s past performance, but they must be duly considered.

Category of securities: The fund’s asset allocation is essential to see whether the portfolio profile meets your investment objective. It helps determine the fund’s diversification and prevents investors from over diversifying funds by making investments in the same type of securities.

Expense ratio: The expense ratio is compared to the returns gained from the fund. The investor can quit the fund if the expenses are too high.

Requirement after investment

The cost-benefit analysis is essential to consider. It requires the review of the funds at regular intervals to ensure that the investment cost is justified by the returns generated. In addition, it is essential to check the risk factor timely. If the risk outweighs the returns, the portfolio has to be realigned to meet the investment objective of the investors.

Advantages of Market Neutral Funds

Fight market fluctuations: These funds withstand market fluctuations in any direction by giving equal weight to short and long positions. The fund manager creates a hedge by buying securities estimated to increase and selling the securities estimated to decrease in prices. Then, when securities perform as expected, the investor benefits from both the positions with returns in each position taken. Thus, these neutralize market movements in your portfolio.

Diversification: Market-neutral funds benefit from diversification apart from its usual meaning, i.e., within the fund.

Disadvantages of Market Neutral Funds

Complex investment strategy: This investment strategy is quite complicated. Investors need to apply correct buying and selling strategies to generate profit.

High portfolio turnover: The assets are traded more frequently under the market neutral fund investment, making turnover relatively high. Taxability is also quite high when units are sold at a premium.

Expertise in fund operation:  Market neutral fund investment decisions are highly speculative. Fund operation requires enormous knowledge and expertise to deal with the same.

High investment cost: Investing in different types of funds makes the cost of investing in market neutral funds relatively high. As a result, the expense ratio of these funds is also higher than the expense ratio of regular mutual funds.

Conclusion

Investment decisions in market-neutral funds require a lot of experience and expertise to maximize returns. Therefore, it is always better to take the experts’ advice to know the various benefits and shortcomings of investing in market neutral funds.

That’s why Comparte Investment team asks do you have “Nivesh Ki Aadat”.

With this one can say “Mutual Fund Sahi hai”,  so let me do Nivesh