This article appeared in the FM Report on 29th April 2022.
2022 has been a very tough year for investors in the 60-40 portfolio in Europe and the US. Equities have suffered double digit declines and government bonds have endured their worst drawdown in decades.
Hedge funds have been put forward as part of the solution as investors increasingly look for alternatives, particularly to fixed income. However, performance in 2022 has again shown that it matters which hedge fund strategies you invest in.
One segment of the industry which has performed very strongly this year is global macro and managed futures trading.
Chart 1: Performance of S&P 500 TR Index and Major Hedge Fund Categories in Q1 2022
Source: Hedge Fund Research/Archive Capital
In Q1, the Hedge Fund Research Global Macro category was up just under 7%, significantly outperforming most other hedge fund categories (Chart 1). Full-month performance data for April, a month when equities and bonds were both down sharply, are not yet available, but higher frequency performance indices point to another very positive month for global macro.
Higher inflation, rising interest rates, geopolitical tensions and more volatility in currencies have created a favourable backdrop for these strategies this year.
What is Global Macro?
In its widest definition, global macro encompasses an array of trading strategies which seek to profit from the movements in what are known as macro markets; typically stock indices (rather than individual stocks), government bonds, commodity futures and currencies.
These markets are considered “macro” markets as their movements tend to be heavily influenced by macroeconomic conditions and macroeconomic policy.
Global macro can be broadly split between fundamental macro and more technical or price-driven strategies.
Fundamental global macro managers anticipate price movement based on analysis of economic fundamentals and geopolitical developments. These managers typically take a discretionary approach but many now use computer models to trade systematically and a growing number use a “quantamental” approach combining quantitative models with discretionary decision making.
Technical or price driven traders typically use some variant of momentum or trend following. The philosophy of trend following is that when market fundamentals change, markets don’t adjust instantaneously but instead trace out major price trends over time which can be exploited by systematic, rules-based trend following strategies.
Long term trends in performance
The 1970s, 1980s and early 1990s were the heyday for global macro trading as the breakdown of the Bretton Woods monetary system triggered big swings in currencies, and high inflation and interest rates produced volatile conditions in bonds, equities and commodities.
Macro trading particularly came to prominence in 1992 as the Exchange Rate Mechanism (ERM) came under attack and George Soros famously profited billions after betting against the pound.
This century performance has been more mixed. The introduction of the euro reduced opportunities for currency trading in the early 2000s. While the Global Financial Crisis (“GFC”) saw macro volatility pick up, the decade after the GFC saw low interest rates and a general decline in market volatility which produced a more difficult market environment for both fundamental macro and trend following strategies (the Jan 2022 episode of the Systematic Investor podcast has a full discussion around this).
However, this decade, first with volatility from COVID-19, and then with the recent sustained pick-up in inflation, macro markets are more volatile and presenting greater opportunities for macro traders.
Why consider Global Macro?
From an asset allocation perspective what makes these strategies interesting for investors is:
(1) historically the returns have tended to be uncorrelated to equities
(2) the strategies have outperformed during significant equity declines and
(3) as they can profit from rising commodities they can potentially generate returns in times of inflation
Table 1: Performance of Major Hedge Fund Categories During Major Declines
in S&P 500 TR Index since 1990
Source: HFRI/Archive Capital
This ability to generate returns during major equity declines differentiates global macro relative to other hedge fund strategies (Table 1 above) and stems from some of the key features of fundamental macro and trend following strategies, specifically:
· the ability to be long or short in each market,
· the high level of diversification trading across many markets,
· the ability to focus risk on the markets where opportunities are greatest.
These factors have been key to the positive performance in 2022. The prolonged rise across many commodities, the rally in the USD and the selloff in global bonds are all major trends which have provided opportunities for fundamental macro trading and trend following.
Despite the selloff in equities this year, valuations by some measures (such as the Shiller CAPE) remain stretched for equities. Although government bonds yields have risen, real yields remain very negative.
With some strategists calling for a potential shift in the global monetary system to a Bretton Woods III arrangement, and de-globalisation and de-dollarisation now the buzzwords in markets, we may be back to an era of greater volatility in macro markets.
Global macro strategies may be worth considering as investors look for alternatives to traditional assets and navigate what has become a more volatile macro environment.
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