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In today’s challenging environment, investors are constantly looking for unique investment opportunities that allow them to participate in equity market upside yet still allow them to sleep at night knowing that they have downside protection.
With stock market pullbacks, volatile commodity prices, low yielding government bonds, and bank accounts that pay next to nothing, what can an investor do? Add in economic and political uncertainty and most investors become paralyzed. We believe that creating a portfolio that includes products designed to provide performance in both good times and bad times is certainly a good starting point. While most individuals own a combination of mutual funds, stocks, bonds and cash, there are other investment vehicles that should be used to round out and truly diversify a portfolio. These investment vehicles, known as alternative strategies, are available with Many different methodologies. Each approach is designed to provide something different to a portfolio and each has its own level of risk.
What most alternative strategies do have in common is that they are designed to diversify a portfolio. Some alternative strategies are designed to reduce your overall portfolio risk; not only through diversification but through downside protection. Unfortunately,these strategies are often not well understood. One such investment product is known as a market neutral strategy.
This type of fund is generally designed to provide equity-like performance over a full market cycle with bond-like volatility. It tends to underperform equity markets when they are very strong, match them when they are mediocre and outperform equity markets when they are down. This type of fund can also be known as an absolute return fund as it strives to provide positive returns each and every year regardless of whether the market is up or down. A market neutral strategy tends to show its worth in negative equity markets like 2011 or 2015 yet maybe not keep up to the strong equity markets of 2013 and 2014. If viewed in a portfolio context and over a full market cycle (which includes down markets), solid market neutral strategies have been able to enhance portfolio returns and reduce portfolio volatility. As an investor, you cannot ask for much more.
Why own a market neutral income fund?
An equity market neutral strategy is designed to provide absolute returns whether the market is up or down. It exhibits zero correlation with the equity markets by holding equal long and short positions in the same sector so an investor is not affected by sector-wide events.
Returns are generated through superior stock picking and not based on broad movements of the market. While a market neutral strategy should not take the place of a diversified asset mix of mutual funds, stocks and bonds, it is a good idea to invest a portion of your portfolio in something that can go up, even when the markets are down.
Where does a market neutral income fund fit in a portfolio?
From our experience, there are many reasons to use market neutral strategies and every investor will look at things differently. We see it fitting in a portfolio in one of three ways:
After combining our beliefs with the thoughts of many investors and advisors, we came up with the following investment guidelines for what we consider an ideal market neutral strategy. We feel that following these guidelines is the best way to satisfy what investors are looking for in today’s markets:
On the surface, the market neutral strategy appears to be complex and, as a result, it is perceived as high risk. In reality, the strategy is designed to mitigate risk. The easiest way to describe it is to say that the fund will go up as long as our favourite ideas (longs) provide better returns than our least favourite ideas (shorts), regardless of whether they are both up or both down. In other words, as long as the stocks we like do better than the stocks we don’t like, the fund will provide a positive return.
We followed these guidelines when we created the Norrep Market Neutral Income Fund at the end of December, 2010. It was designed to provide sleep-at-night returns and has been able to do just that by delivering positive returns every calendar year since its inception. We believe that by staying true to our methodology, we can provide equity-like returns with bond-like volatility for years to come.
Keith Leslie is a Portfolio Manager at NCM Investments. Keith leads two of the firm’s alternative investment strategies, with a focus on Canadian equities. He has over 17 years of investment management experience and is an award-winning Portfolio Manager. Prior…
Portfolio Manager
Tel. 1.403.531.1402
Keith Leslie is a Portfolio Manager at NCM Investments. Keith leads two of the firm’s alternative investment strategies, with a focus on Canadian equities. He has over 17 years of investment management experience and is an award-winning Portfolio Manager. Prior to joining NCM in 2001, Keith worked as a Quantitative Analyst at a western Canadian investment firm.
Keith brings a different perspective to the firm’s investment process, using statistical techniques, valuations tools and modeling. He is the Portfolio Manager of NCM Market Neutral Income Fund, NCM Canadian Enhanced Equity Fund and NCM Core Canadian.
Keith graduated from Western University with a Bachelor of Science in Statistics and Mathematics and is a CFA charterholder.
Unless otherwise stated, opinions expressed in this document are those of the author and are not endorsed by the author’s employer. No guarantee, either express or implied, is made that the information in this document is accurate, complete or up-to-date. The contents of this document are for informational purposes only and are not intended to provide financial, legal, accounting or tax advice and should not be relied upon in that regard. Norrep Market Neutral Income Fund is only available for sale to accredited investors, to qualified investors pursuant to the Offering Memorandum Exemption or with a minimum investment of $150,000.
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