Definition
Market-Neutral Strategy
A market-neutral strategy balances long and short positions so that the portfolio has little or no net exposure to broad market movements, isolating the manager's stock-selection skill.
By matching long and short exposures, an Indian market-neutral fund aims to earn returns from the relative performance of its picks, the alpha, rather than from the direction of the Nifty. Pairs trading and statistical arbitrage are common implementations.
In India, true market neutrality is constrained by limits on cash-market short selling, so shorts are often expressed through stock and index futures. Market-neutral returns can be steady but modest, and are vulnerable to factor crowding and to financing and rollover costs on the short leg.
Related terms
- Pairs TradingPairs trading is a market-neutral strategy that goes long one security and short a related one when their historical price relationship diverges, betting that the spread will revert to its mean.
- Statistical ArbitrageStatistical arbitrage is a class of quantitative strategies that exploit short-term, statistically predictable price relationships across many securities, holding diversified long and short positions to harvest small mispricings.
- Alpha vs Beta SeparationAlpha-beta separation is the framework of distinguishing returns earned from broad market exposure (beta) from returns earned through skill or unique strategies (alpha), and managing each independently.
- Securities Lending and Borrowing (SLB)Securities Lending and Borrowing is a regulated mechanism that lets investors lend their shares for a fee to borrowers who need them, typically to facilitate short selling or settlement.
Plain-English explainer from The Dispatch Investors Encyclopedia. General information, not financial advice.