A market neutral strategy that can reduce risk

Portfolio manager explains how strategy can reduce volatility

A market neutral strategy that can reduce risk

Advisors looking for a better portfolio mix in today’s market should consider a relatively new market neutral strategy that’s become more widely available since the liquid alternative framework was launched three years ago, according to one portfolio manager.

“A lot of people, when they think of alternatives, think of alternatives like private equity, private debt, or real strategy. Market neutral is also an alternative, but a liquid alternative,” Jeff Bradacs, portfolio manager for Canadian Equities with Picton Mahoney Asset Management told Wealth Professional. 

“The market neutral strategy that we run at Picton Mahoney takes existing equities – public listed equities, liquid equities – and we manage those differently to produce a very different outcome for investors. The focus of our market neutral strategy is to provide a positive capital return stream for clients, irrespective of the market direction.

“So, when the markets are going up or going down, we want to do a market neutral strategy that eliminates that volatility of the market and provides a positive return stream for clients.”

Bradacs said while a few companies are doing this, Picton Mahoney has been managing it through offering memorandums for institutional investors for about 15 years. It started offering the strategy more broadly after the alternative framework changed three years ago, and it’s proving invaluable for clients who dislike market volatility that leaves them sleepless.

“We’ve had a great run in equities but as the cycle matures and rates are going higher, we’re seeing a lot more volatility in the market,” he said.

While traditional portfolios are built on bonds and equities, which have previously been nice diversifiers since bonds rise as equities fall, he said those have now become correlated on the downside. The market neutral strategy provides alternative streams that aren’t correlated with equities or fixed income, so help investors reach their goals with more certainty.

“What a market neutral strategy can do for clients is provide a return stream that’s not going to move with your interest rate risk or your equity market risk within a portfolio,” he said.

Bradacs said that’s particularly important now because of the challenges facing the traditional 60/40 asset mix. He added clients are using this strategy to reduce risk in the equity market as well as allocating some of their fixed income to it because of low rates. 

“When you can take out that volatility in the equity market, you can really reduce the volatility in clients’ portfolios,” he said, noting they do that buying and going long equities on one side of the portfolio while shorting companies on the other.

“Yes, we can generate alpha,” he said. “We’re using shorting as a hedging tool. So, we short securities where there’s negative change and we bring it together in a portfolio of longs and shorts and, through risk management, build a portfolio for our clients where we can completely eliminate that market exposure.”

His one cautionary note, however, is to ensure that you have risk management with this. 

“First, you want to look to providers who have done this in the past that can manage risk as you’re building long or short portfolios,” said Bradacs. “Second, with that, is really to focus on the process of a team, and how it generates the returns. You need to be with a provider that has a history of generating returns and has a strong risk management process.”