There’s no way to eliminate all market risk, but you can try to alleviate the threat of a sudden jolt by casting your lot in with a market-neutral fund.
However, there’s no one strategy to get you there. The one-time sector leader, the AQR Equity Market Neutral fund, is currently closed to new investors and has lost 9.1% over the past year. The value-focused fund has taken a global approach to the equity markets but eschews a concentrated portfolio, with 750 long and 613 short holdings.
Although the initial jitters of January and February appear to have dissipated, there are plenty of sources of market volatility lurking around the corner.
‘Investor speculation over when and how quickly the world’s central banks will join the Federal Reserve in raising short-term interest rates and unwinding quantitative easing will continue to lead to volatility in both the equity and fixed income markets,’ wrote the managers of the Calamos Market Neutral Income fund in a recent note to clients. ‘The president’s recent focus on balancing trade through tariffs will also stoke volatility, as investors attempt to determine the magnitude and reciprocity of impending tariffs.’ Buckle up!
Largest by AUM and top by total return
To start, let’s take a look under the hood of the Gateway fund, the largest fund in the space tracked by Citywire. Co-managers Michael Buckius, Kenneth Toft and Paul Stewart of Natixis-affiliated Gateway Investment Advisers also boast the best three-year total returns in the category. A fourth manager, Daniel Ashcraft, lacks the requisite track record having joined the fund in 2009.
The Gateway fund is exposed to typical US equity heavy hitters: Apple (4.09%), Microsoft (3.57%), Amazon (3.09%) and Berkshire Hathaway (1.89%). Where the fund diverges from typical equity managers is in selling index call options and buying index put options. The option trades give the fund protection against short-term market downturns as well as a steady source of cash flow on top of their existing returns.
The Gateway fund has also beaten its peers in terms of performance over the past three years, despite a difficult first half of the year. It lost 0.11% through the first six months of 2018, despite managing to incur less than half of the S&P 500’s 10.1% correction at the end of January and the beginning of February.
The fund celebrated its 40th birthday in December 2017, and according to Natixis, has delivered an average annualized return of 7.54% per year since it launched on December 7, 1977. This compares with the S&P 500’s 11.8% return and 7.35% from the Bloomberg Barclays US Aggregate Bond index over the same period.
The management team said in a recent commentary that market uncertainty over trade policy, inflation and rising interest rates would benefit its low volatility strategy over more traditional portfolios of stocks and high-quality bonds.
Lowest standard deviation
The American Beacon Ionic Strategic Arbitrage fund goes beyond equity index options and futures to incorporate interest rate swaps, mortgage derivatives, credit default swaps and currency forwards.
Over the past three years, its annualized standard deviation has been just 1.4. It also boasts the sector’s lowest maximum drawdown of -1.5% over the same period.
The management team takes long positions in companies’ convertible securities while shorting the common stocks, capitalizing on the price dislocation between the two securities. New York-based Ionic Capital focuses on relative-value arbitrage and event-driven investment strategies.
One to watch
The managers of the Cognios Market Neutral Large Cap fund – Jonathan Angrist, Brian Machtley and Francisco Bido – have delivered a 13% total return over the past 12 months to August 31. This has earned them first place in this sector over the past year – a major improvement after they came in at the bottom of the list for the same period in 2017.
The fund takes long and short equity positions across 226 companies. ‘When you find great businesses and buy them at great prices and then essentially short the worst businesses in the S&P 500, you have the potential to make money regardless of what the individual business does,’ Angrist said.