Investopedia says “what the actual market does won’t matter (much) because the gains and losses will offset each other. If the sector moves in one direction or the other, a gain on the long stock is offset by a loss on the short.” Doubt: If you make money on your long, you offset it approximately by your short positions. Then, where are the $$? I see brokerage costs eating away a huge pie out of your profits, in case you make some after the offsetting effect.
Also, there is nothing called as “free money” and this isn’t risk free also. Where is the risk in this strategy?
Equity Market Neutral means your portfolio has zero correlation with the general stock market. However, you have risk from short and long positions in different stocks.
The key is that the correlation is a correlation of returns, not a correlation of prices. So your losses don’t have to offset your gains.
Finance people frequently say only “correlation” when they (are supposed to) mean “correlation of returns”. The big problem is that, by failing to say “of returns”, they frequently confuse it with correlation of prices, a very different thing.
I am not sure how does that make a lot of difference. Let’s say a stock which I expect to go up is priced at $5…another stock which I short is priced at $50. Let’s say my bet is not correct and the markets don’t behave in the direction favorable to my short position…So, I might lose, I don’t know say, 10% on my short position…at the same time I don’t expect my long to jump more than 10 in this case…So, I lose $5 per share on my short and gain $1 per share on my long…I don’t see how hedge fund managers use this strategy to their advantage.
You do not have to have short positions to be equity market neutral. All you need is a correlation of returns with the market of zero. If your hedge fund earns +5.0% every month no matter what, its correlation of returns with the market will be zero.
In practice, he probably needs long and short positions. He might get an equity-market-neutral portfolio with bonds primarily, or with other investments (e.g., commodities, real estate, baseball cards, whatever), but I’d imagine that it’s really hard to do with a long-only fund.
Can you explain how a manager can achieve an equity mkt neutral portfolio via bonds primarily?
Is it possible to achieve an Equity-market-neutral portfolio via a long-only fund in a theoretical world, like you said we don’t need short positions to be EMN. This idea looks very weird. An example will probably help me nail this one.
Point is I don’t understand how can you be Equity-market-neutral without shorting funds…to have a zero correln of returns with the mkt…you must have short positions; so, if you gain on one and you lose on another…you have zero correlation…I know it is not correln of prices, it is correln of returns…how can you achieve a positive return on one asset and a negative return on another asset without their prices moving in opposite directions from where they(Whatever instrument/fund you take your position in as a hedge fund manager) were initially priced at…this is turning out to be a bit gawky. Can you simplify it for me?
You need to go back and review correlation: if the correlation of returns is negative _ it doesn’t mean that if one has a positive return the other has a negative return _ (though most finance people make this mistake); it means that if one has a return above its mean, the other has a return below its mean. Both returns can be positive.
