The 'Idiot's Market Neutral Fund' - Midyear Update

I first wrote about construction of the idiot’s market neutral fund here and I further addressed the controversy of why the technique may work here. A mid-year update of this hypothetical fund shows that estimated YTD returns to June 30 was 3.5%.

This is ahead of the HFRX Equity Market Neutral Index of 2.3% for the same period. Other investable hedge fund equity market neutral indices (e.g. Dow Jones Equity Market Neutral at 1.5%) show even worse performance than HFRX.

Smart funds remain defensive

The idiot’s market neutral fund’s alpha is mainly derived from the market positions of a group of smart funds. The question in many investors' mind must be what are the smart funds doing now?

The orientation of smart funds hasn’t changed significantly since my last update in late April. Smart funds continue to be more defensive. The managers of these funds seem to believe that the worst may not be over for the US economy.

As the chart below shows, smart fund market beta shows that they are defensively positioned. By contrast, the consensus funds, a group of funds run by the largest mutual fund complexes have market betas roughly in line with the S&P 500:

Smart funds continue to be underweight Financials, while consensus funds are slightly overweight:

 

…and smart funds are roughly market weight Consumer Cyclicals, while consensus funds are overweight:

Comments

[DaveW:]

Am new at this stuff but very curious what the purpose of a 'market neutral' portfolio might be? Why would a person go to the trouble of buying/constructing it vs. parking the same funds in money market? Any enlightenment would be greatly appreciated.

2008 Jul 08 07:56 PM

[Flubadub:]

Funds come and go. They do well then they falter. If they overweight a sector haveing guessed correctly they prosper in the short run. If they are broadbased they move in lockstep with the S&P average. In the end the biggest benefit/detriment comes to those in the highest income brackets. Stocks held are not taxed until sold. They can be given to children who are not taxed until they sell the stock the taxable gain based on the time of transfer not the original purchase price. Of course dividends and interest are taxable at ones nominal tax rate so if you are in the 30% bracket there is a disincentive for purchasing taxable high div securities and gaining money market interest.

2008 Jul 09 09:54 AM