Research

The macro environment

We believe that an investment in a basket of select global macro managers provides an effective way to benefit from a changing global economic landscape, such as we expect to occur in the coming years.

The performance of the global macro sector over the past few years has been somewhat below longer‐term expectations. Our research indicates that global macro investing is well placed to adapt to economic and policy shifts in 2014; a year which could become pivotal for the global economy with far reaching consequences on asset class returns.

In this short paper we will touch on some of the potential consequences of the anticipated economic policy changes and highlight how global macro portfolio managers are in a strong position to benefit from these developments.

Benefits of a Global Macro Approach

Within the context of absolute return investing, global macro investing is one of the purest investment management techniques due to the unconstrained approach that managers are able to employ. The flexibility to simultaneously manage risk and generate performance has proved extremely beneficial to global investors for several decades. Aurum has an active approach to investing in this strategy; while we have held some managers for over ten years, we constantly assess new opportunities that we believe could thrive in the coming years. We do not look at global macro as an asset class, but rather an area where manager selection is of critical importance, with a focus on each portfolio manager's ability to adapt while also having a clear area of expertise.

Tapering in 2014

The most dominant force in global markets over the past five years has been the collective monetary easing and stimulus measures by the world's major central banks. The most influential of these, the Federal Reserve, is now widely expected to begin reducing its current Quantitative Easing policy, commonly referred to as tapering. The markets experienced a 'fire drill' of tapering in mid‐2013 which provided an insight into potential effects of any real tapering that may take place in 2014. Policy shifts often prove especially beneficial for global macro portfolio managers as they profitably navigate the markets. In the next few sections we touch on the potential implications of tapering on various asset classes where, we feel, skilled global macro managers are well placed to benefit.

Asset Class Opportunities:

Fixed Income

USA

After five years of rates anchored near zero, 2014 is likely to be the year when the Federal Reserve comes 'back into play', which we feel is a significant positive for macro interest rate specialists. We have already seen a preview of this shift in policy with the proposal, and subsequent reversal, of tapering in 2013 (as at time of writing). The events surrounding this tapering speculation led to increased interest rate volatility and a significant initial sell‐off in US Treasuries. While the initial taper speech in May caught some fund managers off‐guard (with particular reference to the contagion sell‐off in UK and European rates), we feel that our managers are well positioned to benefit from what will likely be a non‐standard rate hiking cycle, beginning potentially in 2014. Unlike traditional fixed income strategies, global macro managers have an almost exclusive ability to profit from rising rates, with a plethora of instruments at their disposal, including: Fed fund futures, Eurodollar futures, swaps, swaptions, cash bonds, bond futures, forward rate agreements, floating rate notes, and interest‐only securities. These securities can be used in isolation as well as in combination to construct specific trades that optimise the risk‐reward of a particular manager's view towards the future path of interest rates.

With monetary policy becoming more influenced by US politics, several of our managers have built up political advisory and strategy teams in Washington DC and place increased focus on understanding the dynamics of the various stakeholders across the US. We expect more volatility in the US next year in rates expectations and anticipate any 'normalisation' period to ebb and flow given the complex structure of US politics and as economic data develops over time.

Europe

While the European crisis may not dominate financial headlines as it did in 2010/11, several of our managers retain a focus in the region and the ongoing dispersion of economic recoveries across the continent. While trading the euro from a directional perspective has proven difficult for the whole industry, there are more nuanced opportunities for specialist macro rates managers. These include trading interest rate markets outside the Eurozone, where individual countries continue to operate their own monetary policies (e.g. Poland's central bank has cut rates several times in 2013 as growth remains weak). In addition, the ECB further cut interest rates due to the diminished inflation concerns. We expect continued activity in Eastern Europe relative to the European core. Furthermore, we have already seen some of our managers successfully apply US interest rate models to Eastern Europe. We believe this will be a focus for several years and that these pioneering managers are well placed to take advantage of developments in these emerging economies.

Asia

The major interest rate markets in Asia remain Japan, Australia, and Korea, with other markets growing rapidly such as Indonesia, China and Taiwan. Each of these markets are very different and have specific drivers of their respective economies and interest rate policies. While Japan has effectively had zero interest rates for many years, other countries have been far more active and are likely to continue as such in the coming years. For example, Australia will remain an important macro theme for several managers in the coming years; its central bank has cut rates over the past two years in line with slowing Chinese demand for its resources and softening local sectors. With current rates at 2.5% (November 2013), there is further room to cut rates and hence provide opportunities for regional macro specialists. Several of our managers have regional offices in Hong Kong, Singapore, and Sydney, all of which have a focus on the region and its many moving parts.

Global Foreign Exchange

We remain positive on the opportunity set for FX in the coming years, primarily due to the increasing dispersion amongst local economies. Interest rate differentials will begin to increase as it is widely accepted that the US is closer to rate normalisation than Europe, and Europe is closer than Japan. Given that these differentials may be slow to diverge, we have already seen large FX movements driven by strong policy messages, most evident in Yen markets this year, which has been a large performance driver for several funds. Moving away from the largest FX markets, we have witnessed extreme price behaviour over 2013. Capital markets have begun to make clear distinctions between countries with 'twin deficits' and those with healthier sovereign balance sheets. This will become more important in 2014, especially in the context of Fed tapering and the likelihood of liquidity being removed from the global system. Since 2008/09, capital has flowed into emerging markets almost indiscriminately, financed by a zero interest rate policy in the world's reserve currency, the US dollar. This encouraged leveraged 'carry' structures which, after the tapering scares initiated in May, began to unwind drastically. If financing costs rise further in line with policy normalisation, we would expect this performance dispersion in emerging market FX to continue, hence creating opportunities for fundamental macro FX managers. Those countries with sound economic policies and growth prospects should continue to do well, whereas macro analysis should identify those countries and regional economies that were simply beneficiaries of cheap financing.

Global Equities

There remains quite a mixed view towards global equities as an aggregated asset class amongst the macro community. 2013 alone has seen the US and Japan significantly outperform emerging markets as domestic policies in Japan and the US have encouraged the public and institutions to buy riskier assets. Growth concerns in China, as well as widespread emerging market aversion (for various reasons) have led to weaker performance in these areas. This is typically a positive development for global macro funds, as dispersion creates opportunities due to performance being based upon fundamental value rather than capital flows. We expect to witness this behaviour for years to come as the period of easy financing, primarily out of the US, will begin to fade and will force equity markets to behave more in line with fundamental valuations and earnings growth. Alongside country differentiation, we expect clear sectoral themes to emerge. An example of a theme that is gaining some momentum is the revival of the energy sector in the US due to shale gas developments, which may create a variety of opportunities for several years.

Conclusion

We believe that we will see a significant change in the global economic landscape in coming years. The most influential driver of liquidity and asset returns over the past five years has been ultra‐accommodative monetary policy emanating from the US Federal Reserve. As these policies begin to wind down, we believe that the next five years will be very different from the preceding five years in terms of asset class performance. While we had somewhat of a tapering 'fire drill' in 2013, it is now widely accepted that 2014 will see real change to these policies, and will in turn affect investors' behaviour. We believe that a basket of skilled global macro funds have the unique ability to profit from these changes in a number of ways that we have lightly touched on in this paper. Given Aurum's 19 years of experience in selecting successful macro funds, we feel we are strongly placed to deliver our investment objectives in this field of investing amid a changing investment landscape.