For those of you in the hedge fund industry, what is a reasonable return expectation for an equity market neutral fund? I am referring to a fund that is beta netural and the dollar value of the longs and shorts are fairly equal. And what is a decent benchmark for a market neutral fund? The 3 month t-bill? Thanks.
Return expectations vary based on the ability of the strategy to produce alpha (obviously). Think 6% to 12%. If you have the money, I’d suggest buying a few market neutral funds, each with a different selection strategy. This should bring the total allocation closer to the median and avoid periods out outlying performance. But you need different strategies. So a quant fund mixed with a traditional fundamental (long value, short growth) one, and maybe add in one that tilts its net exposure positive/negative. A benchmark? …Good question. No perfect answer. HFRI has a market neutral index that can be used and probably has a fairly good r-squared. The 3-month T-bill wont work because you constantly explaining why the tracking error is so high. There are a couple market neutral mutual funds. Care to share what funds your looking at?
Market neutral funds ought to use some form of the RFR as the benchmark and of course have a beta close to zero. If you’re not taking any market risk, then the benchmark should be something similar that has not market risk. I’m not sure (and perhaps don’t have enough specific experience) to see why the tracking error would be a big issue with 3-month T-bills. Tracking error is basically going to be linked to the volatility of your strategy and perhaps the volatility of holding your cash (i.e. T-bills). In normal times, cash isn’t very volatile. These of course aren’t normal times. The relevant measure for a fund like this is really the Sharpe ratio, rather than some absolute return percentage, since you can to some extent scale the return to whatever the client needs by mixing with cash and/or leveraging. If you need a percentage number I suppose you could take your Sharpe ratio and then scale it to a value equivalent to the risk of holding the S&P or Russel 3000 or something (that’s M^2, for L3 types). I’m not sure what would be a good value for that, but I would think that 3% or 4% above RFR would be fairly impressive, provided that you really do have a beta around zero.
return expectation can vary enormously with use of leverage and are you looking at fundamental or more quanty market neutral funds?
Thanks for the replies. I am looking at a fundamental equity fund. Value oriented. Short “expensive”, long “cheap”, etc.
The long value short growth type fund will go through period of significant underperformance. You’ll need to take apart the track record and look for periods where growth outperforms value to see how the strategy holds up. With the “junk” rally we have seen at points this year, this fund may be lagging in terms of performance. This all support for having more than one mkt neutral fund in the portfolio.