It’s hard to find any area of the financial markets not swept up in the recent whirlwind of volatility, and that has more established investors looking at a controversial strategy aimed at isolating performance from the broader market mayhem.
It’s called market-neutral investing, in which returns are targeted with no regard for movements or general trends in the stock or bond markets.
Some investors want to put their investments into neutral during times of market turbulence.Pavel Pavalanski
Most investment advisors can initiate a market-neutral strategy to certain degrees. Some money managers employ market-neutral strategies only on a client-by-client basis or through market-neutral hedge funds. Among the strategies used are holding long and short positions simultaneously, or buying fixed-income vehicles, or using technical analysis or algorithms.
“People have gotten complacent over the last few years in terms of having easy returns on the equity side. I think the volatility now is definitely making them look at different strategies,” says Nicolas Papageorgiou, chief investment officer for the Canadian division of Fiera Capital Corp. “There’s a big demand as people are trying to diversify away from a frothy equity market and a low yielding bond market.”
Since the Fiera Market Neutral Equity Fund was launched amid the 2008 global financial meltdown, the average return has been 0.57 per cent when markets are up and minus 0.43 per cent when markets are down. But there is no apparent correlation to equity benchmarks such as the S&P 500 or Toronto Stock Exchange. Up to 2018, the fund has posted an annualized return of 2.12 per cent after management and performance fees.
“They are essentially beta-neutral. There shouldn’t be any market exposure,” says Mr. Papageorgiou.
As hedge funds, market-neutral funds are not required to disclose a great deal of information. The Fiera Market Neutral Equity Fund takes long and short positions primarily through pairs trading, where specific long positions are offset against short positions in the same sector.
The fund has a large weighting in energy and materials with long positions in companies such as Parkland Fuel Corp. and Enerplus Corp., but Mr. Papageorgiou does not discuss specific holdings. “Because we have very close relationships with the management of these companies we don’t necessarily like to advertise it,” he says.
Craig Machel, with Richardson GMP.
Craig Machel, a portfolio manager with Richardson GMP, manages market-neutral portfolios for individual clients. Returns vary based on the needs and risk tolerance of each investor, he says, but he claims the strategy can generate average annual returns in the high single digits regardless of how the broader markets perform.
“It’s a bit of a pension-style management, where we have all kinds of return streams and we’re making money in different types of assets,” he says.
Mr. Machel’s arsenal includes a variety of hedge strategies for changing market conditions, including a mix of investments with safe yields, defensive hedge funds and equities with potential for growth.
One strategy generates yields by investing in private real estate such as family apartments with little turnover and student-designated apartments with high occupancy rates.
“The benefit we offer is that we lose very little money in these markets because we own strategies that make money regardless of [interest] rates rising, markets falling or other general macro chaos. Our portfolios are in positive territory for the year, some more than others,” he says.
In response to growing demand for market-neutral strategies, Vision Capital Corp. launched a market-neutral fund with a real estate focus in February of last year.
“We’re looking to do mid-single-digit returns with very low correlation and very low volatility,” says Vision Capital Market Neutral Fund portfolio manager Andrew Moffs.
Vision’s strategy is buying undervalued, and shorting overvalued, real estate investment trusts (REITs). “Our strategy is to buy real estate companies trading at a discount to net asset value and physically short the ones that are either at net asset value or above,” says Mr. Moffs.
As an example, one pairs trade in the Vision portfolio takes a long position in Manhattan’s largest office landlord, SL Green Realty Corp., and a simultaneous short position in Brandywine Realty Trust, a suburban office landlord with properties across the United States.
Mr. Moffs says being able to focus on weakness and strength in the real estate market at the same time helps keep returns consistent. “We’ve taken out the market risk,” he says.
David O’Leary, founder and principal of Kind Wealth.Glenn Lowson/The Globe and Mail
Few market-neutral funds are available on the Canadian market, and tracking – or even understanding – them can be difficult. That has fund analyst David O’Leary from Kind Wealth raising a warning flag for market-weary investors looking for a safe haven. “They’re way too complex. You just don’t have enough information,” he says.
In addition to complicated strategies and a lack of transparency, fees in market-neutral funds tend to be high, Mr. O’Leary says.
But his biggest concern is how these funds might create a false sense of security among investors looking for reliable returns. Some market-neutral funds have proven their worth in the current 10-year bull market, but he says they have no proven track record in a prolonged bear market.
“People buy it believing there is more certainty around market neutrality,” he says.
His advice to investors looking for safe returns in troubled markets: Keep it simple. “You have to understand it," he says. "If you don’t understand it, don’t invest in it.”