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24 Sep 2009

Equity Market Neutral Strategy May Act as a Diversifier Across Market Cycles

Credit Suisse’s Quantitative Equities Group released a new whitepaper, “Equity Market Neutral: Diversifier Across Market Cycles,” outlining the potential benefits of an Equity Market Neutral strategy. The paper details the various types of Equity Market Neutral funds as well as the traits which have historically helped the best managers stand out.

Equity Market Neutral (EMN) funds have been generally successful in profiting from a variety of environments and have provided an effective counterbalance in diversified portfolios during periods of market volatility, such as following the Lehman Brothers bankruptcy in September 2008. The findings of the paper suggest that:

EMN is a potential diversifier given the low beta it showed to the 2008 equity markets in what was a historically volatile year

EMN has lower annualized volatility than other hedge fund strategies over the long term and has provided generally positive risk-adjusted returns over the last ten years

After the significant market dislocation experienced by quantitatively managed funds in August 2007, many managers increased the range of data used, including building proprietary data and risk models, in an effort to try to mitigate the effects of a future mass deleveraging event

In order to achieve diversification within the strategy, investors should seek managers who work with a range of uncorrelated factors and proprietary models in order to avoid crowded trades. This diversification of factors and models was a key element in the strategy’s ability to weather market volatility in 2008 and will likely remain the cornerstone of alpha generation for the strategy going forward in the near term

EMN managers see the post-Lehman landscape as opportunity-rich for the strategy because there is less capital being deployed as well as less competition in program and high-frequency trading.

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