Test of true neutrality

Designed to be a lower-risk/lower-return category of hedge fund, the market neutral sector aims to give between 6% and 10% return a year with lower associated drawdowns.

Charles McNally of Lyster Watson, says: "Unfortunately, a lot of long/short equity funds make no attempt to be market neutral, many end up being more market related than they believe. One of the issues is that market volatility and market level are not independent. While a lot of funds are neutral at the market level, some of their exposure is related to the volatility of the market and therefore their overall position is not just from direct equity exposure. So, in years like this, when you have high volatility, the strategy fails."

Of the 14 funds tracked by Standard & Poor's Micropal over the three years to the end of August, the average fund gained 49.05%. The worst drawdown during the period was 31.84%.

McNally says that 1998 was "such a bad year for the majority of market neutral funds that there is, within the statistics, an element of survivor bias.

"Those that are still standing are doing all right but a lot of the funds pursuing that strategy in the past are no longer with us. "

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