The Attractions of Market Neutral Investing at the Top of a Market Cycle

Many observers appear to agree that we are coming to the top of what has been a powerful bull market cycle which has been interjected but not held back by several exogenous events. These events have served to curtail the cycle on a short term basis only but not turn it into the worst of all things equity; a sluggish bear market. There is no denying that the injection of artificial liquidity from global central banks has found its way into liquid assets and has helped maintain an illusion that all is well but this will, as night follows day come to an end eventually.

As ever with bull cycles, many players get pulled in towards the top as their previously cautious approach to risk assets and, by extension their relative to peers (or index funds) performance numbers are run over by the data presented to them by their asset allocation committees. Frequently, against their better judgement they are forced to join the crowd and “get long”. It is a matter of anecdotal record that retail investors also get sucked in towards a market apex. On finding out that you operate in wholesale equity markets how many taxi drivers ask you what they should be buying next? This occurrence is less common now as the retail market has a new way of separating itself from its cash in the form of crypto currencies but still…….

What, therefore, should investors do to maintain exposure to risk assets but not put themselves at the tremendous risk of a severe equity market correction?

One way of mitigating some very high one delta risk would be to allocate to an equity market neutral strategy. Whilst successfully deployed in all kinds of market conditions, although lagging in performance through a bull run, market neutral should in theory come in to its own when we get to a peak in risk asset valuations. It is an elegant hedge that, if you pick the right provider will give above average returns from a low volatility product with very little downside in a market correction environment. In a study by Alliance Bernstein the following stood out; “A well-designed market neutral strategy should provide excess return regardless of the swings in the equity markets. Therefore, it should help to insulate investors from market crises and periods of unnerving volatility. A market-neutral strategy may also help offset the harm of inflation and rising short-term interest rates, since it should perform well in those conditions”.

There is no panacea here but in a horses for courses world this is a product that should be seriously considered by anyone who has concerns about wider valuations and the possibility of a violent adjustment in equity markets.

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