Cash balance

If you're fairly new to market neutral strategies, this might be quite hard to believe. Nevertheless, it's true: when you are half long and half short stocks, and while both sides are at work, making you money, you will have a high cash balance and earn interest on it.

Granted, it sounds incredible, but that's a fact. Market neutral lets you eat your cake and have it too.

Here's how some brokers do the calculation. Suppose that you have $100,000 in a margin account. You place thirteen different short bets on overvalued stocks for a total $50,000 and buy thirteen undervalued companies for another $50,000. You're market neutral and fairly well diversified.

On the $50,000 short position, you will get paid the short term (e.g. overnight) LIBOR or Fed Funds Effective rates, minus a spread as low as 0.25%. Since 1999, this has meant up to 6.25% interest on half of the money invested; it won't make you rich, but it's free money nonetheless.

If you were to invest $100,000 in a diversified "long only" portfolio, what would your broker pay you? Nothing. And you'd be fully exposed to systemic risk. It really makes you wonder how smart or knowledgeable traditional investors are.