Returns on mutual funds investment are heavily influenced due to market fluctuations. Whether the market increases or decreases, the returns on mutual funds or other investments such as equities are impacted. Market neutral funds are a solution to this volatility. Market neutral funds hedge the risk of such volatility which means that even if the market increases or decreases, the fund stays neutral.
Factors to consider before investing in market neutral funds
There are several factors that have to be considered while investing in market neutral funds. Some of such factors are mentioned below.
- Risk- Reward status : One of the main factors is the risk reward status. The past performance of the fund may not be the sole basis of an investment decision in market neutral funds but they have to be duly considered.
- Type of securities :Next point of focus is the type of securities that form the fund. The asset allocation of the fund is essential information to understand if the profile of the portfolio meets your investment objective. It will also help in determining the diversification of the fund and restrict the investor from over diversifying or buying the funds having the same underlying securities.
- Expense ratio of the fund : Another important checklist is the expense ratio of the fund. This expense ratio is compared to the returns generated by the fund. If the expenses are found to be too high upon this comparison, the investor can make the decision to quit the fund.
Advantages of investing in market neutral funds
There are several advantages of investing in market neutral funds. Some of such advantages are discussed below.
- Ability to withstand market fluctuations: The biggest advantage of market neutral funds is the ability to withstand the market fluctuations in any direction. By buying securities that are estimated to increase and selling the securities that are estimated to decrease in prices, the fund manager creates a hedge. When securities perform as expected, the investor gets the benefit of both the positions with returns in each of the positions taken.
- Allows diversification: Market neutral funds provide the benefit of diversification apart from its usual meaning i.e. within the fund.
Disadvantages of investing in market neutral funds
While we have discussed the advantages of market neutral funds, these funds do have certain inherent disadvantages which are discussed below.
- Complex investment strategy: One of the foremost disadvantages of this fund is the complexity of the investment strategy. To generate returns, the investors have to apply correct buying and selling strategies.
- Higher turnover ratio: The turnover in the market neutral fund is quite high as the underlying assets are traded more frequently. This also results in higher taxability if the units are sold at a premium.
- Requires expertise in understanding the way the fund operates: Investing in market neutral funds is highly speculative and requires huge expertise.
- Higher cost of investment : The cost of investing in market neutral funds is quite high as investing in different types of funds will cost more. Also the expense ratio of these funds is higher than the expense ratio of ETFs or regular mutual funds.
Pointers to help investors make a decision
One of the main tips to make sound investment decisions with respect to market neutral funds is taking the advice of experts. A professional financial advisor can guide the investors about the various benefits and shortcomings of investing in market neutral funds.
Another important point to consider is the cost-benefit analysis. The investors have to review the funds at regular intervals to ensure that the cost paid for investing in these funds is justified by the returns generated. The risk of the funds is also to be kept in check. If the investor feels that the risk outweighs the returns, the portfolio has to be realigned keeping this in mind and ensuring that the portfolio meets the investment objective of the investors.
Conclusion
Market neutral funds provide the benefit of hedging but require a lot of experience and expertise to maximize returns. Hence it is advisable to take professional help of fund managers while dealing in these funds. It is better to consider them a secondary option for investments. It is also essential to review the risk profile on a timely basis to keep the risk factor in check.
FAQs on Market Neutral Funds
A market neutral position is a 50-50 hedge position in either direction i.e. long or short position.
A long position is gained by purchasing the securities that are expected to increase in value and then selling them at such market level. A short position is gained by selling a security that is expected to decrease in value and then buying it at such value. The differential value in each position is the profit gained by the investors.
