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Many hedge funds follow a popular strategy of being “market neutral” meaning they hold the same...

Many hedge funds follow a popular strategy of being “market neutral” meaning they hold the same dollar value of long positions as they do short positions. Why would it be a bad idea to benchmark the performance of such a fund to the S&P 500 index?

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Answer #1

The question is based on the concept of risk neutral investment strategy.

Market neutral investment strategy explains combination of Long and short position in stock market. The hedge fund manager takes long positions in stocks that are expected to increase in price and at same time take equal dollar short positions in stocks that are expected to reduce in price. The major purpose of such investment strategy to minimize net market exposure of hedge fund. Some major reasons for such fund shouldn’t be benchmarked with S&P 500 Index or any other market index.

· The purpose of market neutral fund is to reduce the market exposure

· Fund may have long position in some constituents while short position in some constituents of index.

· Fund performance have effect of bull and bear trend.

· Beta or any relative covariance study can’t be a good indicator for fund performance.

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