Market Neutral Investing: Long / Short Hedge Fund Strategies

Market-Neutral Investing offers insightful strategies to the world of hedge funds. An industry leader, Joseph Nicholas pioneers us through his proven techniques. I highly recommend this book.

Joseph Nicholas is uniquely positioned to write an intelligent book about market neutral investing. He is the founder of a hedge fund research firm that tracks over 2,500 hedge funds and has developed several hedge fund indexes. The language and mathematics within the book are crystal clear. Overall, this book gives you an excellent technical foundation in market neutral investing. As Nicholas describes, the market neutral strategy encompasses eight different substrategies that deal with financial instruments ranging from equities, to convertible bonds, and mortgage backed securities. Nicholas dedicates a whole chapter for each substrategy. Within each chapter, he describes how a specific strategy structures its market neutral positions, how it earns its return, and what risks it bears.Nicholas explains clearly that market neutral investing derives its return not from market movements, but from changes in the relationship or spread between its long positions and its short positions within a certain type of securities. Market neutral investing consists in observing relationships between similar securities; and taking a long position in the ones that appear underpriced while taking a short position in similar securities that appear overpriced. This strategy is called convergence. The investor bets that the spread between the values of securities he is long and the one he is short will narrow. This entails that in relative term, the long positions are expected to appreciate and the short position are expected to depreciate. Thus, the values of the long undervalued positions and the values of the short overvalued positions should converge over time. That would be ideal. It does not always work out that way. Often, the long and short positions respective values do not converge, but diverge. That is what killed Long Term Capital Management. The one caveat is that this book comes across as a commercial for market neutral investing. Nicholas convinces you will earn superior risk adjusted returns vs. regular investing strategies. Also, you will benefit from the market neutral strategies being uncorrelated to traditional stocks and bonds markets. Thus, market neutral strategies provide you with diversification benefits. Regarding diversification benefits, Nicholas is correct. Given that these strategies returns are somewhat independent from market movements in the related securities, it makes sense that they would be uncorrelated to these same markets. Nicholas assertion that these strategies provide superior risk adjusted return is less convincing. I would not be surprised his data is victim of survivor bias. If you select only the funds that survived during your research period, you ignore all the funds that failed during this same period. As a result, you overstate the performance of this investment style by selecting only the strong survivors. Additionally, his time horizon is too short. On page 7, he graphs the risk vs.

Great book. This is the best source for detailed descriptions of hedge fund styles and where their returns come from.

While this book won't prepare you to start your own hedge fund or proprietary trading operation, it is a must read for anyone considering alternative investments. Mr. Nicholas gives the reader a concise and understandable treatment of most hedge fund strategies. Each strategy is covered in its own chapter, including multiple examples of the strategy in action; a simplified explanation of the mathematics the strategy depends upon, a history of the strategy and a comparison of the strategy's historical returns with those of other assets such as stocks, bonds and treasuries.If you are a trader, fund manager or other financial professional you might find the material a bit basic, but your clients undoubtedly would benefit from your recommendation of this book. Even those with advanced finance degrees will likely find this book an excellent overview of the rapidly expanding opportunities in alternative investments.

Joseph G. Nicholas' thorough breakdown of market-neutral investing reveals some common threads and some striking differences between the most common strategies. Most of these strategies, some of which are based on newly developed financial instruments, are not available to average investors or even to many mutual fund managers. Instead, they serve as tools for money managers at the world's largest institutions. Nicholas uses mostly non-technical language and defines all important terms in a glossary, so that even a lay reader can understand. He also keeps math to a minimum. As a result, his book makes the seemingly dry realm of hedge fund investment techniques interesting and accessible while delving deeply into each strategy's approach to risk and reward. We [...] recommend this book to money managers, finance professionals and investors considering a hedge fund investment. But in light of the role that these strategies played in the collapse of former world-beater, Long-Term Capital Management, any student or professional would benefit from gaining at least a cursory notion of how they work - or don't work.