Monday, June 4, 2007

The Do-It-Yourself Market-Neutral Portfolio

"Geoff Considine (Quantext) submits: The hedge fund business has been growing rapidly in recent years—with no end in sight. Wealthy investors are seeking alternative investments to meet their needs and hedge fund managers have an array of tools and strategies at their disposal. One of the core strategies employed by hedge funds is what is called market-neutral investing. A market-neutral portfolio is designed to deliver returns that are not impacted by the movements of the broader market. This does not mean that a market-neutral approach is low risk, however. Goldman Sachs' (GS) largest hedge fund employs market-neutral strategies and has attributed their very poor recent performance partly to this approach.

The defining objective of a market-neutral portfolio is that its returns have low correlation to the broader market. Investors use such funds as a diversifier to their other investments in equities. Low-correlation between assets improves their diversification value. In practical terms, increased diversification means that you can achieve a higher return for the total amount of portfolio risk."

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