Cash neutral is a type of strategy that involves creating a set of buying and selling of financial instruments into a combination which results in no real increase or decrease for the investor. This approach does not involve any net cash, which means the liquid assets of the investor are not tied up in the process at any point in time. A cash neutral strategy can sometimes be helpful in rearranging assets, in particularly hedges, in a way that will position the holdings of the investor to better advantage and pave the way to earn a return in the future.
One of the more common configurations of a cash neutral deal is to pair the purchase of a new asset with a short sale on an asset that is already owned by the investor. The idea is to make sure the combination results in a neutral situation in terms of the impact on the portfolio. While the investor will lose money by short-selling one asset, the plan is to make up the difference with the acquisition of another asset that is projected to generate returns that offset that loss from the short sale.
There are several potential benefits associated with the use of a cash neutral strategy, including the advantage of not having to delve into other assets in order to manage the purchase of the new asset. By conducting the buy and the sale at the same time, there is no need to use net cash or even to make use of a margin account to manage the buy. This means the other assets of the investor remain in place, and are not affected by the transactions in any way.
There are some potential drawbacks to a cash neutral strategy. If the acquired asset does not generate returns to offset the impact of the short sale, this will eventually trigger a net loss. At the same time, if the idea was to unload a hedge fund or similar investment that was anticipated to being losing value in the near future, taking the loss on the short sale may be preferable in comparison to the greater losses that would be realized if the asset had been held. Before actually engaging in a cash neutral strategy, investors should take the time to project all possible outcomes, weigh the risk associated with the activity, then make an informed decision as to whether or not to proceed.
