quity Market Neutral managers attempt to identify overvalued and undervalued equity securities while neutralizing the portfolios exposure to market risk by combining long and short positions. Market Neutral managers typically utilize price, volatility and fundamental valuation metrics either exclusively or in combinations to identify mis-priced securities, and investment holding periods can vary significantly amongst individual strategies. Portfolios are typically structured to be market, industry, sector, and dollar neutral. This is accomplished by holding long and short equity positions with roughly equal exposure to the related market or sector factors.

 

Equity Market Neutral managers may use different approaches to identify overvalued and undervalued securities. The two primary approaches are generally classified as fundamental equity arbitrage which is based primarily on firm information and equity valuation models and statistical arbitrage which is based primarily on quantitative analysis of relative price movements. Each approach fundamentally relies on the relative predictability of returns of particular offsetting baskets of equities. This predictability can arise from a number of factors, including, delayed or exaggerated reaction of markets to new information about individual equities or groups of equities, liquidity selling and momentum-buying. Each one of these strategies involves bearing risks that other institutions may not be willing themselves to bear. For instance, one such strategy involves buying undervalued securities that institutions may not wish to hold (e.g., recent losers or less liquid equities) and selling securities with similar cash flow properties but determined to be overvalued (e.g., recent winners).

 

Broadly speaking, Equity Market Neutral programs derive their profitability from the efficient use of information regarding related but distinct equities, the willingness to bear risks that other institutions are unwilling to assume, and the persistence of imperfect arbitrages.