Market Neutral still a diversifier despite a tough 2018, says Zenith


With Australian equities performing solidly and consistently in recent years, the negative 2018 calendar year served as a sharp reminder that alternative sources of returns can be an important diversifier of a portfolio.

However, alternatives in the form of Australian market neutral funds largely turned in a relatively disappointing performance over 2018, with Zenith’s rated funds returning an average of -3.2% (after fees), which was roughly in line with broader Australian equities.

Despite this, Quan Nguyen, Zenith’s Head of Equities, believes equity market neutral strategies offer investors a return stream that is not correlated to traditional asset classes over the longer term, which acts as an important portfolio diversifier.

Nguyen said, “It is important to remember that market neutral funds are expected to have no correlation to equities over the longer term, not negative correlation. As such, there may be short periods where market neutral strategies exhibit similar directional movements as equities”.

“However, in these relatively isolated instances where both experience negative returns, we expect market neutral strategies to protect capital, as was the case in late 2018”.

Zenith noted that over the December quarter drawdown, the average Australian equity market neutral fund outperformed the broader Australian equity market by 3% (after fees).

“Long-term equity market data shows that Australian equities have had one negative year approximately every four years since 1984. While the recent strength of equities markets may have potentially given rise to complacent investing, 2018 was a reminder that alternative sources of returns are required to ensure balance within an investor’s portfolio. Equity market neutral strategies offers investors a return stream that is not correlated to traditional asset classes over the longer term”.

The drivers of negative returns

Nguyen stated that there were two main drivers of performance for Australian market neutral funds over the 12-months ending 31 December 2018.

“Whilst volatility returned to equity markets, low levels of dispersion across individual stocks resulted in an unproductive environment for active managers.”

“In addition, the typical long bias that Australian market neutral funds maintain towards smaller companies created a strong headwind during the year. Smaller companies underperformed their larger counterparts by 5.6% over the year.”

Zenith noted that Australian market neutral funds typically maintained a net-long bias towards smaller companies, given the challenges of enacting short positions in this segment of the market.

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