The term market neutral is used loosely; funds that use it have shown a range of returns.
Photo: Michele MarconiFew investment strategies aimed at Main Street are as baffling as the seemingly simple “market-neutral.”
The term, affixed by the funds industry to dozens of mutual and exchange-traded funds, imparts a safe, Swisslike feel. It suggests a strategy closely linked to market performance, like index funds offer. But there is little uniformity among these products, and that is reflected in a disparity in their performance as well.
In its glossary of investment terms, Morningstar Inc. defines market-neutral funds as those that “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,” or those betting against stocks. The glossary also says such funds keep their P/E ratios and industry exposures the same for both their long and short positions.
In practice, however, many funds that market themselves as market-neutral drift from that definition. Some mainly seek to balance long and short strategies, like the BlackRock Global Long/Short Equity Institutional open-end fund (BDMIX), with $549 million in assets as of July 1. Some, such as IQ Merger Arbitrage ETF (MNA), with $680 million, base their strategy on merger arbitrage, betting that announced mergers will close and so attempting to capture the spread between market and deal prices. The former fund was down 1.04% in the volatile period from Feb. 20 to April 30. The latter was down 4.87%.
The variance of strategies used by funds that refer to themselves as market neutral is, perhaps, why returns for the group are so scattered.
“The term market neutral is used extremely loosely, “ says Bill DeRoche, chief investment officer and head of AGFiQ Alternative Strategies at AGF Investments LLC in Boston, which, paradoxically, perhaps, has had both strong and poor performers in the market-neutral sector this year.
Perusing a Morningstar list of ETFs that refer to themselves as market-neutral, in the period from Feb. 20 to April 30, both the best and worst performance came from AGFiQ. Its AGFiQ Market Neutral Momentum ETF (MOM), with $5.9 million in assets as of July 1, gained 9.52%. And its AGFiQ Market Neutral Value ETF (CHEP), with $710,000, lost 16.16%.
Returns for of all the 50 market-neutral mutual funds and ETFs on Morningstar’s list, meanwhile, ranged from 12.57% for Hussman Strategic Growth mutual fund (HSGFX), with $307 million as of July 1, to minus 16.50% for Causeway Global Absolute Return Institutional mutual fund (CGAIX), with $9.4 million.
“There shouldn’t be this range of returns,” says John C. Adams, an associate professor of finance and real estate at the University of Texas at Arlington who has published research critical of the moniker market-neutral.
Definitions for market-neutral are “kind of all over the place,” says Prof. Adams, who adds, “These are just not good mutual funds. From February to April, this should have been their time to shine.”
A spokesman for Causeway Capital Management, adviser to Causeway Funds, declined to comment for this article.
“Seems like there’s a huge luck component,” Prof. Adams says. “We should see some consistency with the strategies.”
“It kind of goes with the idea that these are pretty actively managed,” he says. “And, on average, when you have a lot of active management, that performance tends to…go down.”
If there is a silver lining, Prof. Adams offers it might be that capital outflows have increased for many market-neutral funds. “If they are bad, at least the investors appear to recognize that,” he says.
Mr. Ravo is a writer in Seattle. He can be reached at reports@wsj.com.
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