Managers and allocators give greater latitude to idea of ‘market-neutral’ hedge funds
As market-neutral managers look beyond asset weights long and short to define their practice – and make their returns – there are clear signs some of the longest-standing and most influential allocators to market-neutral funds are giving them flexibility to do so.
Harald Sporleder, who is a director European equities and investment style leader for hedge funds at AGI, sums up plainly some investors’ views on the historic model for much market-neutral management: “For market neutral, the general perception is, ‘do we need such products at all?'”
To ensure the answer is ‘yes’, he argues market-neutral managers must use further sources of alpha available, such as country and sector exposure, to produce enough alpha.
“The product structure only based on pairs trades is not enough to generate decent alpha,” he says, adding his fund has only at most 10% of its assets in such trades.
Last year to October, Sporleder’s sector peers seemed to struggle, making 2.2% on average, while hedge funds overall made 4.8%, according to Hedge Fund Research.
The standard investment approach for many market-neutral managers – of betting on how prices of related securities will move in relation to one another, while allocating equal assets long and short – has been negatively hit by developments since 2008.
One was that share prices have often moved in unison according to political or ‘macro’ factors, rather than on the merits of the company involved. This made predicting one stock’s future movement difficult, and arguably forecasting movements of two linked securities even more difficult.
Sporleder says: “Market-neutral strategies linked to pairs trading works the best in EMs because these markets are inefficient, but we are in more efficient markets and we have to add value through different alpha sources.”
A second negative development has been the magnification of effects of ‘factor exposures’ during the crises.
A manager putting all money on the factor of high volatility, for example, lost about 10% in the first half of last year alone, according to software providers Axioma.
Managers exposed heavily to short-term momentum lost over 12%. ‘Growth’ and ‘medium-term momentum’, meanwhile, generated gains of over 2%.
This means market-neutral portfolios with equal long and short books could have their performance heavily influenced, for better or for worse, by such factors.