Mar 2018 by Joe Burns
As a growing number of central banks around the world reverse their policies of monetary stimulus, investors should take the opportunity to reassess alternative investment strategies. Global macro funds may be poised for a resurgence as the market cycle shifts from one of calm to increasing uncertainty.
Global macro encompasses a vast array of trades that hedge funds can pursue to take advantage of changing economic and geopolitical policies. Trades can include stocks, bonds, currencies, commodities and derivative instruments. Hedge fund managers often make decisions based on indicators such as interest rates, exchange rates, unemployment, industrial production, foreign trade and liquidity flows in constructing their portfolios.
The source of returns from a macro perspective is often driven by changes in fiscal and monetary policy or market structure derived from a macroeconomic shift. Post-crisis, these shifts have been relatively slow-moving and peripheral, thus limiting the impact of trade construction and profit generation for most macro-focused funds. However, in an environment with a wider dispersion of potential outcomes driven by decentralized economic policies and a changing impact on asset classes globally, macro investors have more opportunities to generate uncorrelated returns with minimal dependency on equity markets.
Many macro funds performed exceptionally well during the last financial crisis. As stocks plummeted, global macro strategies outperformed equities by a considerable margin in 2008, with the S&P 500 falling1 -37% as the HFRI Macro (Total) Index2 rose by 4.83%.3
In the subsequent bull market - fueled by unprecedented quantitative easing on the part of the Federal Reserve, European Central Bank and their counterparts in other markets - stocks have easily outpaced global macro funds. In 2017 for example, the S&P 500 returned 21.83% as the HFRI Macro (Total) Index returned just 2.21%.4
However, with available data going back to 1990 we see that the HFRI Macro (Total) Index has outperformed the S&P 500 Index on an absolute basis with half the level of volatility, far less downside risk and minimal correlation to U.S. equity markets over that 28- year period (through Feb. 2018). Historically, macro funds perform best during periods of elevated market uncertainty and increased volatility, an environment not usually conducive to directional “risk- on” strategies.
Macro managers can build a portfolio and express their views in a relative value or directional construct. Fixed income and volatility arbitrage are two types of relative value strategies whereby managers seek to exploit discrepancies in the prices of related financial instruments. These strategies become more interesting and potentially profitable as interest rates rise and global asset classes diverge in response to a new macroeconomic paradigm.
Hedge funds frequently construct fixed income arbitrage trades by executing long/short positions between bonds and interest rate swaps, for example. These types of trades are usually driven by a manager’s view about changing monetary policies and the corresponding impact of different securities across the yield curve. Asset-backed securities such as collateralized mortgage obligations (CMOs) or collateralized debt obligations (CLOs) can also be utilized.
Between September 2007 and December 2008, the Federal Reserve took target interest rates from 5.25% to e ectively zero, where they remained until December 2015. Since that time, the Federal Reserve has raised its benchmark rate 5 times, with another 3 (and possibly 4) rates anticipated to occur in 2018.
Additionally, the Fed initiated massive asset purchases to stimulate the economy after the crisis, in the process sending its balance sheet skyrocketing from under $900 billion in 2008 to over $4.5 trillion by 2015. As of February 2018, the balance sheet remained over $4.4 trillion5, but in October 2017 the Fed began shrinking its balance sheet in small increments with a goal to get the total figure to under $2.5 trillion within the next few years.6
The United Kingdom and Canada recently began hiking rates as well, and central bank officials in the European Union and Japan also have started discussing early-stage ideas about curtailing their prolonged near-zero interest rate policies.
Such shifts in monetary policy point to changes in the global economic cycle that traditionally have instigated higher market volatility and investor uncertainty. Ultimately, investors should expect widening credit spreads, greater price divergences among currencies and commodities, and risk assets presenting both long and short profit-generating opportunities as these uncertainties increasingly impact global markets.
Investors have much to absorb as the macroeconomic and geopolitical landscape is evolving rapidly, such as the potential impact of fiscal stimulus, monetary policy divergence, the prospect of contentious foreign trade negotiations, and threats to regional stability in emerging markets with valuable resources. Historically, such environments have been highly profitable for macro investing, far more so than strategies that are generally correlated with the unidirectional appreciation of risk assets. Thus, the question remains: is the tide finally turning for global macro?
(1) S&P 500 Index: The Standard & Poor’s 500 Index (S&P) is an index of 505 stocks issued by 500 large companies with market capitalizations of at least $6.1 billion.
(2) HFRI Macro (Total) Index: This index tracks investment managers who trade a broad range of strategies in which the investment process is predicated on movements in underlying economic variables and the impact these have on equity, fixed income, hard currency and commodity markets.
(3) “S&P 500 Annual Total Return Historical Data,” YCharts. https://ycharts.com/indicators/sandp_500_total_return_annual “HFRI Macro (Total) Index Performance History,” HFR. https://www.hedgefundresearch.com/indices/hfri-macro-total-index
(4) “S&P 500 Annual Total Return Historical Data,” YCharts. https://ycharts.com/indicators/sandp_500_total_return_annual “HFRI Macro (Total) Index Performance History,” HFR. https://www.hedgefundresearch.com/indices/hfri-macro-total-index
(5) “Recent Balance Sheet Trends,” Federal Reserve. https://www.federalreserve.gov/monetarypolicy/bst_recenttrends.htm
(6) “Market Thinks Fed Could Hold Off on Rate Hikes for Another Year — At Least,” CNBC, Aug. 29 2017. https://www.cnbc.com/2017/08/29/market-thinks-fed-could-hold-offrate-hikes-for-another-year-at-least.html
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