Research paints neutral funds in dark light

Investors and their advisers have been warned to halve their exposure to ‘market neutral’ strategies, with research house van Eyk reporting a shortage of suitable investments despite demand in light of fears of a declining share market.

The revised strategy is contained in van Eyk’s 2004 Australian Market Neutral Equities Overview, released by the influential research house today.

The report revealed market neutral fund managers - which simultaneously constructing ‘long’ and ‘short’ equity portfolios - provided poor returns last year compared to traditional, or ‘long’ Australian equities fund managers.

Van Eyk’s initial recommendation of a 10 per cent ‘market neutral’ strategy this year was based on the diversification advantages it offers investors, due to a low correlation with the performance of other major asset classes.

However van Eyk analyst Dennis Mothoneos said capacity issues have constrained the use of existing funds.

“Market neutral managed funds have relatively strict capacity constraints because of the limited number of securities that are available for fund managers to ‘short’, or sell,” he said.

“Once they reach these constraints they need to close so as not to degrade performance.”

Mothoneos added that the strength of the share market over the past 12 months had not been conducive to adding value through ‘short’ portfolios.

“The neutral fund managers reviewed in the van Eyk report returned between -5.7 per cent and 10.5 per cent to June 30, compared to 21.7 per cent by the ASX/S&P 200 Index and 5.3 per cent for cash,” Mothoneos said.

Despite their underperformance, Mothoneos said investor demand for market neutral strategies remained strong and may increase as fears of a decline in the share market intensify, following its recent highs.

“If they do so, however, they’ll soon discover there’s only a small number of these funds still open to new investors,” Mothoneos said.