In bull markets, investors rarely think about it;
But every time prices crash, many wish they had done more to protect their portfolios. Some investors try to decorrelate their portfolio by looking for sources of returns that do not depend on broader markets. That type of returns comes within the scope of absolute return strategies, which are based on the objective of providing some degree of risk mitigation for portfolios.
Equity market neutral strategies aim not to be dependent on any particular type of market environment. Their objective is generating excess returns and making the portfolio as insensitive as possible to market fluctuations.
How do they do this?
There are different types of strategies that exist. At Candriam, we believe combining complementary strategies is key to delivering performance. As an example, index rebalancing strategies are more effective when there are significant levels of dispersion of returns in the markets.
For our part, we have studies showing that relative value strategies typically perform well when the dispersion of returns is low.
It means that when these two strategies are combined, they can offer effective diversification benefits and provide good risk-adjusted returns regardless of market direction.
Combining complimentary approaches can also offer an answer to the question whether an equity market neutral strategy can produce gains in most market environments. Utilised in portfolio comprising asset classes such as bonds, real estate and commodities, an equity market neutral strategy can stabilise the overall performance of a portfolio.
As these strategies are less correlated with most traditional asset classes, they can also help reduce the portfolio's volatility and therefore its risks.
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