After being hammered in 1999 and the first quarter of 2000, most market-neutral managers have made a comeback in the last nine months of this year.
Perhaps the most stunning performance was delivered by Aronson + Partners, Philadelphia, whose market-neutral strategy is up 56% since the trough in the first quarter -- a hefty 51.5 percentage points over the benchmark Treasury bills -- and up 24% for the first 11 months of the year, 18.6 percentage points over T-bills. The firm's market-neutral strategy was down 27.2% last year. Aronson + Partners lost almost half of its assets in this strategy because of poor performance and client outflows in 1999, and now manages a $400 million portfolio.
Meanwhile, Standish, Ayer & Wood, Boston, logged returns of 16.5% for the January-Dec. 7, 2000, period, or 11.08 percentage points over the benchmark three-month T-bills, compared with a loss of 11% last year, or down 15.7 percentage points compared with the benchmark. The firm manages about $330 million in market neutral, down from around $400 million at its peak, said David H. Cameron, director of equities.
Numeric Investors, Cambridge, Mass., which runs around $1.1 billion in market-neutral strategies, produced returns of 12.8% for the 11 months ended Nov. 30, or 7.2 percentage points over the 5.6% benchmark of T-bills. In contrast, the firm's strategy lost 1% last year. The firm uses two models, picking stocks that are both "quality" and increasing earnings, but are reasonably priced, as well as a model that recognizes improving earnings trends. Like most other market-neutral managers that seek to insulate returns from market swings by betting on winners and shorting stocks they believe will do poorly, Numeric aims to produce returns of six to eight percentage points over Treasury bills.
In comparison, the 15-plus market-neutral managers in Frank Russell Co.'s universe had an average return of 5.2% for the first nine months of the year, a stark contrast to the -2.8% in 1999. In the third quarter of 2000, the average for the universe was 3.7%, the highest since 1997, when market-neutral managers had a very good year, said David Jensen, senior research analyst at The Frank Russell Co., in Tacoma, Wash.
In a recent fax to clients, Theodore R. Aronson, managing partner of his eponymous firm, summed up his feelings in one word, "Hallelujah!"
Most market-neutral managers use computer-driven models to help screen stocks. In addition many, including Aronson, also have value biases that proved to be nearly suicidal when investors ignored the connection between earnings and stock prices and stampeded to buy high-octane technology stocks in 1998 and last year.
"When you're down 20%, you look in the mirror and begin to wonder if you have a double-digit I.Q.," Mr. Aronson said.
Another manager that uses a value tilt, AQR Capital LLC, a New York-based quantitative manager, saw gross returns of 15% for its Absolute Return Fund for the 11-month period ended Nov. 30, and 35% since the inflection point in mid-March. The firm also runs $80 million in the Global Asset Allocation Fund, which does not have a value bias, and was therefore not affected by the huge split between value and growth stocks until sometime in the first quarter. It was up 24% for the first 11 months, said Bradley D. Asness, vice president.
"I'm trying very hard not to be excited," said Clifford S. Asness, managing principal and co-founder, part of the group that broke away from Goldman Sachs Asset Management's quantitative investment group in 1998. (The two men are brothers.) AQR runs about $460 million in long-short strategies and is optimistic about landing more business next year.
Out-of-favor "value" stocks are still relatively cheap, and investors do not have to give up much in earnings potential relative to growth stocks, so they are cheaper than they should be, said Clifford Asness.
The break came in March, when investors in Internet-related stocks began heading for the exits. The Nasdaq market has been in a meltdown since then, and was down 36.06% in the first 11 months of 2000. "The same factor working against (market-neutral managers) in 1998 and 1999 has turned in favor of them," Frank Russell's Mr. Jensen said.
Up in the downdraft
Market-neutral managers, he said, buy stocks that are cheap and short stocks that are expensive, a strategy that misfired in 1998 and 1999, but is working well in the current downdraft. Value stocks are ahead of growth in small, midcap and large stocks for the year. The Russell 1000 Value index was up 1.85% for the year through Nov. 30 while the Russell 1000 Growth index was down 19.87%; the Russell 2000 Value index was up 11.12% and the Russell 2000 Growth index was down 26.86%; and the Russell Midcap Value index was up 9.41% while the Russell Midcap Growth index was down 16.1% .
Mr. Aronson anticipates that market-neutral strategies will do well for the next few years because value stocks will be back in vogue.
Market-neutral, or long-short, managers tend to do better when the market is down. They seek to exploit inefficiencies in the market, most apparent in times of high underlying volatility, allowing them to produce stock-like returns with far lower risk.
"When markets are going up 20% or 30%, no one cares about market neutral. But now that people realize that markets don't go up all the time, the phones are beginning to ring," said Bobby Hill, chief investment officer at Shenandoah Asset Management, Richmond, Va. His firm opened in March with $11 million in a market-neutral strategy. The strategy is up 9.8% since April 1, said Mr. Hill, previously director of equity at the Virginia Retirement System.
But not all market-neutral managers have recovered fully.
Robert D. Arnott, chief executive officer of First Quadrant, Pasadena, Calif., expects it might be another year before market-neutral managers are on firm ground and begin drawing new money. "Ironically, the best time to invest in the strategies was after the downdraft in the first quarter, but no one would touch them then," he said.
First Quadrant, which manages $1.4 billion in such strategies with a "modest" value tilt, was flat for the year through early December, but down four percentage points or so compared with the benchmark T-bills, Mr. Arnott said.
Investment Research Co., Rancho Santa Fe, Calif., a quantitative manager that runs $100 million in a market-neutral portfolio with a deep value tilt, is still hurting. Its performance was seven percentage points below its benchmark last year and is still lagging the benchmark, the London interbank offered rate, this year, said John D. Freeman, president. He expects market-neutral managers will have a stronger showing next year.
"There's a lot of pent-up demand for market-neutral investing, and (pension funds) are just waiting for a period of pretty good performance by long-short managers before increasing their commitment," he said.
Another manager with a value bias looking to make a comeback is AXA Rosenberg Investment Management, Orinda, Calif., whose strategy was up nearly 12% since June, but down 1% on an absolute basis for the first 11 months. The firm, which runs $500 million in that strategy, expects it will do better as investors return to fundamental stock analysis.