Market Neutral Indicator

Market Neutral Indicator

A market neutral indicator seeks profits from an investment strategy that is based on an investment portfolio created to track a certain indicator (hereinafter "underlying indicator"). The strategy combines short positions to hedge market risk in accordance with certain rules. It is generally a type of enhanced indicator (an index that seeks certain investment results based on an investment strategy).

Traits of Market Neutral Indicators

If the underlying indicator is not a market capitalization weighted indicator of the broad market ("conventional indicator") but an indicator that selects constituents and adjusts their incorporation ratio based on certain rules (e.g., smart beta indicators), profits are expected to surpass that of the conventional indicator by some extent (α or alpha).
A market neutral indicator is designed to measure such excess profits.

Example of expected investment results

Excess profits are not always guaranteed; the profit ratio may turn negative (i.e., loss) in a rising or falling market.

Example of losses

A market neutral indicator is expected to generate returns regardless of the rise or fall of the overall market (i.e., neutral to market) as measured by a conventional indicator.

Comparison between Market Neutral Indicators and Underlying Indicators

  • Market neutral indicator: Long Short Strategy Index on MSCI Japan IMI Custom (Gross) 85% + CASH (JPY) 15% Index
  • Underlying indicator: MSCI Japan IMI Custom Liquidity and Yield Low Volatility Index

Differences in Returns Compared to ETFs Tracking the Underlying Indicator

An ETF tracking a market neutral indicator will result in gains/losses under different situations as compared to an ETF tracking an underlying indicator. An underlying indicator is made up of the constituents, and the constituent ratios are different from those for a conventional indicator. However, since an underlying indicator is basically affected by overall market moves to a great degree, its returns largely track the moves of a conventional indicator. In contrast, a market neutral indicator reflects the difference in the deviation rate between its underlying indicator and a conventional indicator. As such, overall market moves are irrelevant to its returns. In addition, the day-to-day price moves of a market neutral indicator tend to be smaller than those of its underlying indicator.

Notes on Investment Style

While investors can expect a market neutral indicator to reduce losses in a falling market, such indicators may also limit opportunities for gains in a rising market, and the day-to-day price moves tend to be smaller. Investors are reminded to bear this in mind with regard to the expected investment results when making decisions based on overall market moves or seeking short-term gains.