Market Neutral Fund - huh?

[Rich_by_the_Bay]

Can anyone explain that Vanguard fund to me? I read about it while investigating the Managed Payout Funds (it's about a 10% holding). All I can glean is that they pay money to advisors to achieve a beta that is comparable to the general stock market.

So why not just buy the total market index? The neutral fund returns don't seem extraordinary to me. Do they actually have less beta than the total market?

So what's the advantage and what am I misunderstanding?

 

[saluki9]

Rich, they are paying the managers to have a beta of zero, not that of the market which would be 1.

This is a long/short strategy which is common among hedge funds. In theory the funds will be long and opposing short exposures that cancel each other out. The idea is to make stock selection the sole factor in return.

 

[Rich_by_the_Bay]

Rich, they are paying the managers to have a beta of zero, not that of the market which would be 1.

This is a long/short strategy which is common among hedge funds. In theory the funds will be long and opposing short exposures that cancel each other out. The idea is to make stock selection the sole factor in return.

OK, that makes sense. From the prospectus:

The Fund follows a market neutral strategy, which the Fund defines as a strategy designed to produce a portfolio that is neutral with respect to general stock market risk, sometimes referred to as beta neutrality.​

I misinterpreted that to mean same as the total market.

The advantage of such a fund is as an inflation hedge? A bear market hedge?​

 

[bamsphd]

For most, it is another asset class with low correlations to the usual asset classes. So basically bear market protection. It is generally possible to find some existing "Market Neutral" fund which when back-tested would have nicely smoothed out the return of a multiple asset class portfolio.

Investing in such a fund does require you to believe that humans, willing to be hired, can make money after expenses by picking stocks. If you think fund managers are just lucky coin tossers, then this is not a good investment approach for you.

 

[Rich_by_the_Bay]

It now makes sense in the Managed Payout funds where the endowment mentality is important. Ballast.

 

[cute fuzzy bunny]

Rich...pull up the fund on the vanguard web site and click down to the actual individual holdings. You'll see a whole bunch with positive dollar amounts up top and a whole bunch with negative dollar amounts down at the bottom.

This link may or may not work:

https://personal.vanguard.com/pub/Pdf/mnhold.pdf


Market neutral funds will generally try to hold the shares of a company they feel is undervalued and due for a rise in a particular sector, then short the shares of another company in the same sector that they feel is overvalued and due for a fall.

If either bet succeeds, the funds value improves. If both bets succeed, it improves a lot. Even my wan opinion of stock picking agrees that most of the time you can get at least one bet to succeed.

The downsides are that like all stock shorting schemes, there is no end to the amount of money that you can lose. The trading costs can be large. The fund has to pay the dividends for shares it holds short to the owners, raising the expense ratio.

But generally, given better than mediocre picking skills and a close eye on the holdings, the fund should produce at least a modest positive gain in almost any market.

BTW, I wouldnt mind if this one piece was absent from the managed payout funds. It jacks up the ER quite a bit, and I'm not that thrilled with unlimited downside risk even if its only a small percentage of the fund.

 

[Rich_by_the_Bay]

Thanks - good explanation. Sounds like the payout funds need it as a way to trade returns for principle protection.

 

[cute fuzzy bunny]

That and a steady return in all markets. Picked well a 'market neutral' fund will produce a return every year in excess of the CPI. I think the 'market neutral' nomenclature is sort of a misnomer. Any market neutral fund that didnt gain ground more years than not would be a market neutral fund without a whole lot of money invested therein.

So I guess the naming is intended to say that the returns are not tied to any particular type of market, rather than the fund sitting at an average of zero up and down.

Returns AND principal protection.

In the biblical sense, a market neutral fund names the risk its going to avoid and then demonstrates no correlation to that risk. The vanguard fund states its intent is to avoid stock market 'risk' as defined as volatility. So the fund achieves its stated goals when it produces a positive return regardless of the stock markets level of volatility.

I'm just not a big believer in them. Probably because in general they underperform in up markets and...umm...underperform in down markets too, while costing too much in every market...

I guess if you had a moderately successful one, you'd fire the guy who picked the worst gainers/losers and have one heck of a managed fund that'd be advertised as pro-long or pro-bear.

 

[ziggy29]

I'm just not a big believer in them. Probably because in general they underperform in up markets and...umm...underperform in down markets too, while costing too much in every market...

Same here. I mean, the goal of significantly beating cash returns and inflation with very little additional risk just seems...well, too good to be true, which likely means it is.

These funds don't have enough of a track record for me to trust them. And even if they did work sometimes, how much of that would be dumb luck and how much some "proven" new strategy?