MARKET NEUTRAL INVESTING Many investors are concerned that the U.S. equity markets are “Fully” if not “Overvalued” and not sure where we go from here. On one hand, the Bull market in the U.S. is well into its 7th year and stock values in U.S. equities as measured by Price Earnings Ratios are toward the higher end of the range with some areas of the market being in bubble territory. On the other hand, compelling evidence exists that the Global Economic Recovery remains in its early stages with Europe, China Japan and others providing U.S. style economic stimulus (QE) to their economies in the form of low interest rates and or the purchase of bonds and other assets from banks to free up capital to be put back into the system. Most rational observers see the merits of both views and are simply confused while carrying the lessons of 2008 and 1999 fresh in their minds and psyches. Many investors are looking for direction to avoid steep losses if the bears are correct yet, want to take advantage of the continued upside if the Bulls are still right and we are in the early stages of the Global Recovery with the U.S. haven taken an early lead. In summary these investors feel as follows:

Market may be approaching a Top, or is due for a pull-back

Do not want a repeat of 2008 by being fully exposed

Seek positive returns in both Up and Down Markets

Concerned with market volatility and would like protection

Generally the options that investors consider for protecting against investment losses include the following:

Selling and going to Cash

Investing in Bonds

Buying Alternative or Uncorrelated Assets

Owning Defensive Stocks such as: Food, Beverages, Utilities, Pharmaceuticals, etc.

Short Selling Overpriced Stocks

Acquiring Protective Puts and/or overlaying with a Call writing strategy

Rotating to deeply discounted or beaten down asset classes

And while each of these strategies offer benefits and risks, all involve some element of Market Timing, something that most agree is difficult if not impossible to achieve and can result in exacerbating and compounding the very losses that the investor is seeking to avoid. One strategy that we believe makes sense in a mixed signal market such as the one we find ourselves in is a True Hedge Fund or a Market Neutral Fund. Unfortunately, the term Hedge Fund has become a catch all label for a variety of different strategies involving virtually every investable asset class in which the manager may be short. The mechanics of achieving market neutrality involve being simultaneously long and short in an equal number of positions. Short positions rise in value when a market declines, while long positions increase when markets advance. Thus, in the event of a market sell-off the overvalued stocks should decline more than the undervalued holdings. In this scenario, the portfolio will generate a positive return. However, if the market sell-off is indiscriminate, that is everything sells off equally, then with market neutrality, the portfolio should generate a zero return, no gain and no loss. i Some managers juxtapose long and short positions using market sectors, industries or even countries or currencies. That is, they are long (Own) stocks in the industries that they believe are going to rise and Short (Sold) stocks in the industries that they feel are overvalued and due to decline. The concept can be applied against currencies, asset classes and countries, etc.:

Long U.S, Dollar Short The Euro Long Gold Short Oil Long India Short China

However, we believe that portfolios with a skilled manager who builds a portfolio stock-by-stock, buying companies that are undervalued due to something other than fundamentals and short selling companies that are overvalued for reasons other than fundamentals. Non-Fundamental reasons for stocks to be undervalued include: market overreactions to an earnings miss; overall (indiscriminate market sell-off); currency devaluation for non-U.S. Stocks; short-term geo political tension. Over valuation drivers include: momentum; investor plowing in because nobody want to miss the action: Excitement over the story; company is an industry disrupter or at the cusp of a new paradigm, etc. A True Market Neutral Portfolio will hold long and short positions in similar percentages rather than tilt its exposure and attempt to bet on the direction of the market. The goal is to “zero-out” broad market risk and capture the spread between overvalued and undervalued stocks.

The preceding represents the views and opinions of The Stanley-Laman Group, Ltd., a Registered Investment Advisor serving individual and institutional investors and is not intended to be investment advice suitable for all investment objectives. The investment strategies above can result in the loss of principal. A long-short or neutral strategy such as outlined offers inherent risk.