Tuesday, July 8, 2008

Idiot’s market neutral fund: A mid-year report card

I first wrote about construction of the idiot’s market neutral fund here and I further addressed the controversy of why the technique may work here. A mid-year update of this hypothetical fund shows that estimated YTD returns to June 30 was 3.5%. This is ahead of the HFRX Equity Market Neutral Index of 2.3% for the same period. Other investable hedge fund equity market neutral indices (e.g. Dow Jones Equity Market Neutral at 1.5%) show even worse performance than HFRX.

Smart funds remain defensive
The idiot’s market neutral fund’s alpha is mainly derived from the market positions of a group of smart funds. The question in many investors' mind must be what are the smart funds doing now?

The orientation of smart funds hasn’t changed significantly since my last update in late April. Smart funds continue to be more defensive. The managers of these funds seem to believe that the worst may not be over for the US economy.

As the chart below shows, smart fund market beta shows that they are defensively positioned. By contrast, the consensus funds, a group of funds run by the largest mutual fund complexes have market betas roughly in line with the S&P 500:

Smart funds continue to be underweight Financials, while consensus funds are slightly overweight:

…and smart funds are roughly market weight Consumer Cyclicals, while consensus funds are overweight:

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