Is now the time to be considering adding macro to your portfolio?
In recent years, hedge funds have underperformed relative to investor expectations. And that point has not gone unnoticed, with a slew of articles and white papers written on the issue that question the value that hedge funds provide. Discretionary macro investing – one of the industry’s oldest strategies – has struggled more than most. The HFRI Asset Weighted Composite Index has delivered a compound annual return (CAR) of just 2.7% over the last five years, but the HFRI Macro Index fared even worse, with a CAR of just 0.65%.
A strong argument often cited as justification for an allocation to global macro is the expectation that the strategy can potentially outperform other strategies during periods of higher market volatility, such as 2008.
Macro also tends to focus on more liquid asset classes, which are easier to trade at times of global stress. Extending the period of review to capture the “Global Financial Crisis” shows a tangible improvement in the figures as shown in the chart above: since January 2007, the HFRI Macro Index has delivered a CAR of 2.19% (as at Feb 2019) versus 2.84% for the MSCI World and 5.70% for the S&P 500. But figures like these hardly set the pulses racing; they simply give journalists more ammunition. They may also explain why the global macro strategy has fallen by the wayside from an allocator's perspective as shown in the chart below.
A case for under-allocation to macro?
Of the funds we monitor AUM has grown at a rapid pace since 2009, but there has been a steady decline in the proportion of that capital going to macro strategies. A key question that allocators should be asking is whether they are underweight global macro in their portfolios. If so, is that under-allocation justified given the current stage in the economic cycle and expectations for future market volatility?
Of course, the headline data may not tell the whole story, and we continue to believe in a strategy that has been a pillar across portfolios advised by Aurum Fund Management Ltd. since its inception just under 25 years ago.
Perspective is everything
Our statistics highlighted above aggregate the performance of an entire space into a single number, but we should be careful about how we interpret this. It is important to note that in a strategy such as macro, the underlying funds actually represent a highly diverse range of approaches and styles – in stark contrast to more homogenous strategies such as long-biased equity or credit.
Diversification is key
In Aurum’s recent article, ‘The Quest for the Holy Grail’, written by my colleague Ana Johnson, she outlined the importance of diversification and how that could be achieved via thoughtful strategy selection. Her analysis showed that within some hedge fund strategies, the underlying funds tend to move more in lockstep with one another; on the other hand, some strategies tend to exhibit less synchronised behaviour in the underlying funds. Indeed our data set shows global macro has one of the lowest intra-strategy correlations, as illustrated in the chart below.
So why do global macro funds exhibit this type of behaviour? There are several explanations, but the simplest comes down to the extremely broad nature of trading activities that fall under the global macro classification.
As a strategy, global macro allows portfolio managers the freedom to express views across all asset classes and geographies as they see fit and where they see the most opportunities. On top of this, the approach and focus can differ tremendously; for example: ‘old-school’ directional macro; relative-value-tilted strategies; emerging-market focused; derivatives-heavy strategies focused on rates and FX; short-term traders with time horizons less than a week, etc.
Looking beyond the index level
Appreciating the variation in the underlying funds that fall under the global macro umbrella is a critical factor when appraising the ‘value’ of macro from an allocator’s perspective. Simply viewing performance at the index level is not representative and obscures some of the potential benefits of allocating to managers from that space. The performance statistics themselves can also be calculated using varying methodologies and can give a very different picture. For example the macro funds contained within Aurum’s proprietary Macro Strategy Index have compounded at 2.97% using an equally weighted methodology, whilst on an asset weighted basis the Index shows a 4.43% compound. For interest, the HFRI Macro Index shows a 2.19% CAR over the same period, the difference explained by variations in HFRI index composition as well as slightly differing calculation methodology. The largest funds – where investors hold most of their capital – generated stronger performance than on average. They demonstrated strong ‘dollar-extraction’ and superior risk-adjusted performance for their investors.
Our strategy analytics engine shows that since January 07, of the global macro funds we monitor, they have generated net dollar profits (after fees) of over $64 billion, as per the chart below. This compares to profits generated across all hedge funds we monitor of $1.1trillion.
A challenging period, but opportunities may lie ahead
It is no secret that developed market directional traders have been through a challenging spell in the years since the Global Financial Crisis. Ultra-low interest rates, quantitative easing by many central banks, a collapse in volatility in several asset classes and to a certain extent the changing demands of allocators (weekly estimates, transparency, lack of tolerance for drawdowns) have arguably all contributed to the overall underperformance of the strategy.
However, that is no reason to disregard macro strategies as a whole. In the last 10 years, for example, relative value strategies have been able to generate strong returns, exploiting inefficiencies in rates and FX markets. Funds that have been able to navigate emerging markets have also seen strong performance, whilst macro managers who are comfortable to express thematic views using equities/equity-baskets have been able to take advantage of the large opportunity set on offer. In other words, if you keep an open mind and conduct thorough research, there are a number of high-quality macro managers out there. And again, our work on cross-correlation and strategy dispersion shows that macro is one of the strategies where allocators can add significant value via a strong bottom-up manager/fund selection process.
Strong headwinds continue to buffet the markets
“Markets are constantly in a state of uncertainty and flux and money is made by discounting the obvious and betting on the unexpected.” - George Soros
It would be easy to look at recent articles in the media and conclude that the days of macro funds are numbered. It would also be easy to be lulled into a false sense of security by the investment environment witnessed in the last decade. Volatility and global interest rates have been at - or near – all-time lows, while equities and other risk assets have enjoyed a sustained long-term period of outperformance relative to their history. Growing uncertainty around monetary policy and the weakening of global economic data, combined with increasing global tension and protectionism, represent the greatest headwinds we have faced in recent years.
Global macro stands to benefit from increased volatility
Global macro remains one of the hedge fund strategies where talented portfolio managers have historically shown an ability to navigate more challenging market conditions. We also strongly believe that liquidity is undervalued and that is another reason why an allocation to a highly liquid strategy such as macro is appealing. The benign environment of the past decade has seen investors move down the liquidity curve in a hunt for yield, potentially setting a trap in their portfolios. If the environment becomes more volatile, with risk-premia repricing and investors searching for the safety of more liquid assets, we would expect global macro to be a potential beneficiary of such a shift.
At Aurum, we believe an allocation to macro is an important part of our investment philosophy and it is something we have done for nearly 25 years. We have always aimed to add value through our manager selection and through diversification of sub-strategies within the space; this gives the ability to build a macro portfolio capable of withstanding both a benign environment and times of market stress.