Market neutral has long been a safe haven option for many investors, enabling them to avoid market risk, but can such investments be profitable?
Citywire Selector spoke to three market neutral portfolio managers to hear their best sector ideas.
Nick Judge, who runs the Man GLG Alpha Select Alternative fund alongside Charles Long, said he is taking a contrarian stance in market neutral as the sector is potentially more attractive than it has been for some time.
‘Valuation dispersion across sectors is currently higher than it has been for several years, providing potential opportunities for market-neutral returns.
‘In addition, due to the unpredictable course of Brexit negotiations, many investors with a wider remit are eschewing the UK market, which in turn, could add to the opportunity set.’
Judge currently sits joint first place in the market neutral sector alongside Long, having returned 11.7% over a one-year period, and said a good example of valuation anomalies lies in the commodity space.
‘The differential between the mining and large cap integrated oil stocks is significant. A large number of the large cap mining stocks could generate significant free cash flow yields in 2018 at current commodity prices.
‘Their balance sheets are in robust shape, with some of them being in a position to potentially return capital to shareholders in the near future. In contrast, the oil majors have been trading on lower free cash flow yields at current oil prices, and their balance sheets are currently geared towards the top end of their self-imposed limits.’
Judge said unless some extreme moves in the relative commodity prices are made then the valuation differential is not likely to persist.
‘Equity markets remain dominated by macroeconomic data, central bank policies and political themes. However, as investors get more clarity on these developments, the focus is likely to shift back to company fundamentals and with that to a better environment for fundamental stock-picking strategies.'
Kastner said the team tends to have high exposure to consumer sectors, industrials, IT and healthcare but has traditionally had low or no exposure to energy or basic materials.
‘Tactically, we pay attention to the development of intra-sector return dispersions which gives an indication of how much the market is differentiating within the sectors.
‘Currently, we observe a rise of intra-sector return dispersions in IT, consumer discretionary and industrials while it remains muted in health care and consumer staples.’
‘Macroeconomic uncertainties have faded away and cross-equity correlations are low, which has historically been favorable to active managers. However, equity factor returns, as measured by the MSCI Factor Indices, have experienced significant divergences.
‘This means that not all active management styles are benefiting from the current environment. For instance, in spite of the reflationary economic environment that prevails in Europe, value underperformed the MSCI Europe by almost 2% year-to-date as of 14 July. Low volatility underperformed by 3.6% due to its negative sensitivity to interest rates.’
On the other hand, Bolliger said momentum and quality outperformed the market by 1.2% and 2.8% respectively, with these divergences being the underlying importance of running equity L/S short portfolios that are able to provide diversified exposure.
‘The current environment is particularly challenging for managers who run sector-concentrated portfolios,’ he added.