Solving the Equity Market Neutral Dilemma

The Equity Market Neutral sector, currently comprising more than 100 hedge funds in the U.S., serves as an important element of diversified portfolios yet has long underperformed for individual investors due to undifferentiated approaches and misaligned incentives.  With tens of billions of dollars invested in market neutral hedge funds (and similar amounts invested in an additional 100 ETFs and mutual funds), an effective solution to this problem is long overdue – and Subset Capital is working to provide it.

During the five year period 2013-2017, market neutral funds compiled a category average net return less than 1% with a negative Sharpe ratio (as reported by Hedge Fund Research).  It seems few such funds are able to offer the ABCs investors require: meaningful Alpha, low Beta (market correlation +/- 0.3) and reasonable Costs (to limit erosion of gross returns).  This failure occurs because most market neutral offerings are built using the same ideas, methods and resources as long-only funds – an inherently problematic approach.

Subset created an equity market neutral fund working with these ABCs in mind.  We have a proprietary methodology for processing emergent data sources in a patented system that results in significant alpha, very low correlation to the markets, and a low-cost, highly scalable strategy.  Add to that an investor-friendly performance fee structure, and Subset’s flagship fund significantly outperforms benchmarks.

The strategy features quantitative models that use new data sources (including blogs, micro-blogs and social data related to equities, see below for examples), macro market variables and fundamental company data.  These models continue to evolve with new sources of data and with machine learning. Resulting signals are statistically monitored and systematically traded under the supervision of experienced traders.

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But creating above-average value with below-average costs doesn't help the investor if the gains aren't passed along.  So Subset Capital inverts usual fee structures, putting LPs first:

  • there is a hurdle rate, so Subset doesn’t get paid until partners get some returns

  • there is no management fee — only direct expenses — with a 1% cap — so that LPs get the benefit when the fund grows while Subset focuses on being good before being big, and

  • there is payout alignment, so Subset only does better as the partners do better and we avoid the typical scenario of an underperforming fund keeping all the profits for itself:

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Too many investors have had to choose to pursue either low correlation or solid returns.  With innovative fund strategies and client-focused fund terms, Subset aims to solve the dilemma.