BlackRock

A market neutral equity fund holds a large number of stocks in both long and short positions, so the net asset value is near zero. In theory, this means that the value of the fund should be fairly insensitive to overall market fluctuations. The fund’s performance depends entirely on the skill of the fund manager in buying (going “long”) stocks with a better chance of going up, while selling short a suite of stocks that are likely to perform more poorly.

Fund managers use criteria (“factors“) such as value, momentum, quality, and mean-reversion to select which stocks to go long versus short. Investors see market neutral funds as a means of producing maybe 4 to 8% return (alpha), with relatively low volatility and low exposure to overall market movements (i.e., low beta). Institutional investors love funds like these for adding diversification to their portfolios, so they hold many tens of billions of dollars of market neutral funds available only to them.

We lowly retail investors have access to some such funds. I will just focus here on two of the larger and more successful retail market neutral funds, offered by AQR Capital Management, and by BlackRock, respectively. These appear in a mutual fund wrapper, instead of an ETF. As with many mutual funds, there are different investor classes for a given fund family. If you invest a huge amount of money, you get the lowest annual fees (e.g., for QMNIX and BDMIX “Institutional” classes), but all the classes for given fund are invested in the same underlying strategy and assets.

To try to put these on the same basis for comparison for us ordinary folks, I will look at versions of each of these funds that do not require over $1 million additional investment, and which do not have an obnoxious (5.25%) upfront sales load. QMNNX is offered by AQR. It holds some international along with US stocks, and is constantly tweaking its long and short portfolio based on a proprietary set of factors, which are based on an enormous amount of data and calculations. The strategy behind BlackRock’s BDMCX is somewhat different. It probably uses similar types of factors (value, momentum, mean-reversion, etc.), but it tries to specifically match long and short companies within industry categories. Thus, in theory, it should be relatively insulated from a crash of say software stocks, since it is long and short in equal amount in that category.

OK, let’s look at actual performance. Here is a 10-year chart, with QMNNX in orange, BDMCX purple, compared to the S&P 500 in blue and BND (total bond market) in light green.

This chart might make you run screaming out the door – both funds did so poorly in the 2016-2021 timeframe that their ten-year total returns are far less than the broad market. But this is not really a fair comparison. These vehicles are not intended to compete with a 100%-long portfolio. A better comparison is to bonds, and it can be seen that both market neutral funds beat BND (green line) handily over this time period. It is worth noting that the AQR fund QMNNX got decimated in the 2018-2022 – – that was a time when the market rewarded ONLY growth, even for stocks which scored badly on traditional “value”. Thus, QMNNX was long the value stocks which were shunned by the market, and short the tech stocks that roared upward. So, while the overall market was ripping upward, QMNNX went down and down and down, losing some 30% of its value while its investors lost faith and sold out. The within-industry matching for BlackRock’s BDMCX protected it from such gross losses, though it showed only modest gains in that 2016-2021 time period.

The picture changes entirely when we look at a five-year timeframe (below). QMNNX’s value tilt was finally vindicated in 2022, as the fund soared while tech stocks crashed. Three cheers for diversification! The fund kept up an absolute positive edge over the mighty S&P 500 for each of the years 2023, 2024, and 2025. It seemed like AQR had cracked the code for superior equity returns. Its five-year return is more than double that of the S&P, which is stunning. Meanwhile, BDMCX kept up a steady performance, roughly matching the S&P, but with much lower volatility. That is pretty good. Meanwhile, the rises in interest rates trashed the returns of bonds (green line).

The picture shifts again when we look at one-year total returns (below). BDMCX continues to roughly match the S&P. This is a significant achievement when stocks are in a big bull run, showing that the BlackRock fund managers continue to make very good calls on prospective weak vs strong stocks. QMNNX had a poor first half 2026, with an absolute decline. For some reason, its factors did not correctly forecast relative stock performances. It has started to recover some mojo in the past few months, enough to beat out the long-suffering bond market.

My personal takeaways are:

We cannot expect this type of fund to routinely beat or even match overall stocks. However, as diversifiers, they might be compared to say bonds or REITs, and they hold up well in that comparison. The overall U.S. market (dominated by big tech) has been going up so much, for so long, that it may seem like any diversification away from stocks is a waste. Time will tell.
The stellar (market-matching or even market-beating) performances seen for QMNNX and BDMCX over the past five years are probably largely flukes, and should not be relied on going forward.
Due to its rigorous within-sector net neutral construction, BDMCX is unlikely to soar, but it is also unlikely to crash. I think of it as a “Steady Eddie”. The looser construction of QMNNX gives it the freedom for great outperformance (especially in a tech crash), but makes it more vulnerable to extended losses if the market moves against its view of reality.

Disclaimer: Nothing here should be taken as advice to buy or sell any security.

Apart from some possible geopolitical upset (and theater with the debt ceiling), the Big Issue for the larger economy, and for investing decisions, remains how fast inflation will decline – since that governs how soon the Fed can relent on keeping interest rates high. Those high interest rates are having all kinds of knock-on effects, including bank failures and suppressed home sales.

The investing market seems to be pricing in expectations of significant Fed rate cuts before the end of 2023, which in turn presupposes that inflation will have ratcheted downwards far enough by then to allow the Fed to declare victory. Goods inflation (= mainly stuff made in China) has declined nicely, but services (which comprise the majority of household spending) remains high. It is coming down, but too slowly to realistically hit the Fed’s 2% target this year.

In an article in the Seeking Alpha site title Services Inflation Is Stuck, the investment firm Blackrock notes some technical factors that will likely keep services inflation high for at least the remainder of this year. I will paste in their text in italics:

Core Services ex-Shelter inflation is a bit of a hodgepodge that includes things like medical care services, video and audio services, tuition, and insurance. It comprises roughly a quarter of the CPI basket and, importantly for the Fed, is very domestically oriented.

A key insight from this article is that nearly two-thirds of this key “Core Services ex-Shelter” component consists of:

(1) Service prices that are regulated (especially insurance), and

(2) Services with infrequent price resets (such as tuition and especially medical services):

There are technical factors that make it likely that these particular items will see ongoing, sticky inflation:

Impact of Regulated Prices

Regulated prices tend to be more discrete and more lagged in their changes due to bureaucratic delays and their negotiated nature. Some types of regulated prices, like postage or water and sewage fees, are easily recognizable as subject to government regulation. Somewhat less intuitive is the degree to which insurance in the United States is a regulated price. Insurance comprises the largest share of Core Services ex-Shelter basket and state-level insurance commissioners play important roles in negotiating auto, property, and casualty insurance price changes.

The underwriting costs of insurance have been surging globally – a combination of higher reinsurance premiums, inflated asset values, and more natural disasters. These rising costs have only just begun to flow through into consumer prices; auto insurance costs were an upside surprise within March’s CPI report.

Jumps in Medical and Education Prices Will Appear Later

Though the market has been fixated on the painstaking details of the month-over-month inflation prints, many of the sub-components of the CPI do not update monthly. Two of the more important items within the core services basket – medical care services and tuition – only update their prices annually. Coincidentally, updates for both of these categories take place in the autumn, and both are set to rise strongly.

Medical care services are the largest component (28%) of Core Services ex-Shelter, but have a complex and lagged computation and update only once a year in October. Medical services inflation has been negative since last October as a consequence of excess consumer demand for post-pandemic doctors’ visits, however, we expect this mechanical effect will abate later this year and thereafter lift core services inflation.

Tuition is another example of a service with intermittent price resets, given prices are set on the basis of the academic year. We expect the broad-based upward wage pressure in education to be passed through to higher education consumer prices later this year when students return to school.

And so…I expect “higher for longer” inflation and interest rates.