There's a trend among wealthy investors that has been gaining momentum since the market meltdown five years ago. It's called market neutral investing. Unlike conventional investing, which attempts to tie returns to market gains, market neutral investing tries to generate returns regardless of the direction of the broader markets. It usually involves complicated hedge strategies such as short selling, which makes money for the investor when the price of the underlying security drops.
The growing popularity of market neutral investing is a tacit admission from the finance industry that it could be years, perhaps even decades, before equity markets show significant gains.
It might be difficult for younger investors to wrap their heads around the fact that 2007 marked the end of a 25-year bull market — the longest bull market in modern history. From the early 1980s going back to the end of the Second World War major global stock markets flat-lined in comparison to the late-century rally. If the past repeats itself, looking at a long term chart of the S&P 500 Index might send chills down any long-only investor's spine.
Market neutral investing is currently the domain of wealthy investors because it requires large amounts of capital and skilled money managers who charge fat fees to manage those funds. Those two requirements have a hefty price tag, which translate into high minimum entry fees of as much as $500,000.
Several market neutral funds and investment services have set up shop over the past few years to cater exclusively to the wealthy demographic — until now.
Toronto-based One Financial has launched Canada's first series of long/short funds aimed at filling that market neutral niche with regular investors. An initial investment of $500 will get you a piece of the action.
"We're trying to provide a solution that offers some upside return potential that you might pursue in the stock market with much less downside risk," says One Financial CEO Jeff O'Brien.
The One Financial fund series, called the All-Weather Profit Family, consists of twelve funds that run the range of asset classes including Canadian, U.S. and international equity, as well as bonds. According to One Financial, the funds themselves can hold just about any investment product — stocks, bonds, commodities, currencies, exchange traded funds. The fund managers also have the flexibility to be as much as 100 per cent long or 100 per cent short. In comparison, many conventional long/short funds have limits on what portion of the fund can be short.
Investors looking for entire market neutral portfolios can choose between six wrap accounts — packaged portfolios that range from conservative to growth, and hold different mixes of the All-Weather funds.
Fees are slightly lower than most comparable mutual funds. Annual fees, known as management expense ratios, are below 2 per cent. In addition, an optional front end load (when the fund is purchased) or back end load (when it is sold) is imposed to compensate the broker. The All-Weather funds can be purchased through the investment arm of most major financial institutions. Like many hedge funds, a performance fee of 20 per cent is added to any gains.
What about the risk?
Hedge funds have gained a reputation for being highly leveraged and very risky — and for good reason. They are generally unregulated and don't require a great deal of disclosure.
O'Brien says his funds eliminate that level of risk by imposing what are called stop losses on both long and short positions. A stop loss is a pre-set trigger to sell if an investment falls below a certain price, or in the case of a short position, above a certain price.
"Our whole investment strategy is about a very disciplined approach to cutting the losers and riding the winners," says O'Brien.
For that reason he says the All-Weather funds are technically not even hedge funds. "We aren't a hedge fund in the traditional sense of the word because we are fully regulated, transparent, we have daily liquidity and we're audited."
Hedge funds have been around forever but many of the latest market neutral funds and services — like the All-Weather funds — have a long way to go to prove their long-term viability. Some market neutral strategies actually target annual returns and invest according to those targets. Either way the focus is less on rolling the dice and hoping an investment will go up, and more on managing risk ahead of returns. Achieving both — at least for now — is the Holy Grail of investing.