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An investment strategy or portfolio is considered market neutral if it seeks to entirely avoid some form of market risk, typically by hedging. In order to evaluate market neutrality, it is first necessary to specify the risk being avoided. For example, convertible arbitrage attempts to fully hedge fluctuations in the price of the underlying common stock.

A portfolio is truly market neutral if it exhibits zero correlation with the unwanted source of risk. Market neutrality is an ideal which is seldom possible in practice. A portfolio which appears to be market neutral may exhibit unexpected correlations as market conditions change. The risk of this occurring is called basis risk.

[edit] Equity market neutral

Equity market neutral is a hedge fund strategy that seeks to exploit investment opportunities unique to some specific group of stocks while maintaining a neutral exposure to broad groups of stocks defined for example by sector, industry, market capitalization, country or region.

The strategy holds Long / short equity positions, with long positions hedged with short positions in the same and related sectors, so that the equity market neutral investor should be little affected by sector-wide events. This places, in essence, a bet that the long positions will outperform their sectors (or the short positions will underperform) regardless of the strength of the sectors.

[edit] Examples of Market Neutral Strategies

• Delta neutral hedging, is an example of a market neutral strategy.

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