What it means
Markets are often described as bullish when prices are expected to rise and bearish when they are expected to fall. Neutral sits between these views.
An investor who is neutral on a company or sector does not see a strong reason to buy more or to sell. Brokerages use the word in research ratings.
A neutral rating on a share normally means the analyst thinks it will perform roughly in line with the market or its peers, and it is close in meaning to hold. Some firms use neutral as a softer alternative to a sell rating, so many investors read it with care.
Portfolio managers use the term for their asset allocation. A neutral weighting in equities means holding the same proportion as the benchmark or the long-term target, for example 60% in shares if that is the policy.
Being overweight or underweight then expresses a view relative to that neutral point. Traders also build neutral positions on purpose.
A market-neutral fund holds both long and short positions so that overall market movements largely cancel out, and a delta-neutral options position is set up so its value barely changes for small moves in the underlying price. These strategies aim to profit from other factors, such as the difference between two companies or changes in volatility.
Economists use neutral in another way, as in the neutral interest rate, the level at which monetary policy neither speeds up nor slows down the economy. The exact figure cannot be observed directly and is estimated by central banks, so views differ.
Whatever the context, a manager should check what the neutral point is being measured against. A neutral view is not the same as no view, and it is not always safe.
An investor who stays neutral in cash while prices climb may miss out on growth, and one who stays neutral in shares during a downturn can still suffer losses. Neutral means not taking a directional bet, which is a decision in itself.
In practice
Real-world examples.
Example
A bank's research team publishes a neutral rating on a food manufacturer after its share price has risen 40% in a year. The analyst explains that earnings growth is already reflected in the price. Clients who own the shares are told they can keep them but should not add.
Example
A pension fund has a long-term policy of 60% shares and 40% bonds. Its investment committee sees no clear signal and keeps the allocation at that neutral mix. On a $500,000,000 portfolio, that means $300,000,000 in shares.
Example
A hedge fund buys $20,000,000 of shares in one car maker and sells short $20,000,000 of shares in a rival. The position is market-neutral, so it gains if the first outperforms the second whether the market rises or falls. Its risk is that the first company does worse than the rival.
Case study
Seen in the real world.
Pinewood Asset Management is a fictional fund house, and this illustrative story shows how a neutral stance works in practice. Its strategy team believed that the outlook for shares was uncertain because company profits and interest rates were both moving in opposite directions. They decided to hold the portfolio at its neutral weights of 50% shares, 40% bonds and 10% cash.
Over the next year, shares rose 12% and bonds were flat, so a more bullish fund would have done better. However, the neutral stance avoided a mid-year fall of 8% in the equity market that would have hurt an overweight approach. The head of strategy told clients that neutral did not mean idle, because the team continued to review each holding.
At the next review, the committee shifted two percentage points from cash into shares after profit forecasts improved. Because the move was small, it expressed a mild positive view while staying close to the neutral mix, and the policy was recorded in the minutes so clients could see how the decision had been made.
Watch out
Common mistakes.
- Reading a neutral rating as a recommendation to buy. It usually means the analyst expects average returns and does not see an obvious opportunity.
- Believing a neutral portfolio carries no risk. It still moves with markets and can lose money in a downturn.
- Confusing neutral with market-neutral. The first describes a view, while the second describes a strategy with offsetting long and short positions.
Questions
People also ask.
What does a neutral rating mean for share price?
It suggests that the analyst expects returns in line with the market or sector, not a large gain or loss.
What is the neutral interest rate?
It is the rate at which policy neither stimulates nor restricts the economy, and it can only be estimated.
Is a neutral view the same as selling?
No, it means holding or staying at the target weighting, though some investors use neutral ratings as a quiet signal to reduce positions.
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