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Diversifying Market Risk through Market-Neutral Strategies

Posted: 5 May 2002  

Marco A. Navone

Finance Discipline Group - UTS Business School; Bocconi University - CAREFIN - Centre for Applied Research in Finance; Financial Research Network (FIRN)

Date Written: September 19, 2001

Abstract

Usually hedge funds are linked to concepts such "superior selection ability" and "abnormal returns" (subject to abnormal risks). Recent literature has pointed out that seldom hedge funds achieve performances significantly higher than broad capitalization market indices or mutual funds, and that basically hedge funds are just a different way to rule the agency relation between investors and the investment manager. From this consideration follows that one of the most important features of hedge funds is the manager's ability to take both long and short positions on the markets. Combining long and short positions in the same portfolio an hedge fund can rule out market risk and obtain a stream of returns uncorrelated to market returns. What I point out in this paper is that even without superior selection abilities by the hedge fund manager the uncorrelation of market neutral strategies with market returns can encourage mutual funds manager to invest a relevant portion of their portfolio in market neutral hedge funds. Simulating simple market neutral strategies on the European stock market from 1980 to 2001 I demonstrate that mixing these portfolios with traditional benchmark portfolios (the tipical mutual fund) fund manager can obtain significant risk reduction whitout the typical illiquidity costs that arise from investing in less developed markets, the ones where one can obtain similar low levels of correlation whith advanced countries stock markets.

Keywords: Momentum, Hedje Funds, Market Neutral Strategies

JEL Classification: G11, G14

Suggested Citation

Navone, Marco A., Diversifying Market Risk through Market-Neutral Strategies (September 19, 2001). Available at SSRN: https://ssrn.com/abstract=306700

Marco A. Navone (Contact Author)

Finance Discipline Group - UTS Business School ( email )

Haymarket
Sydney, NSW 2007
Australia

Bocconi University - CAREFIN - Centre for Applied Research in Finance

Via Sarfatti, 25
Milan, 20136
Italy

Financial Research Network (FIRN)

C/- University of Queensland Business School
St Lucia, 4071 Brisbane
Queensland
Australia

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