Outlook for Macro Strategies

Not just a case of reading the runes

Originally published in the May 2007 issue

As part of their ongoing investment process, the hedge fund research analysts of the HSBC Alternative Investment Group (AIG) review the factors that drive the different hedge fund strategies. The output from this research is available on a monthly basis and the main conclusions for the global macro strategy are set out below.

Global macro is the investment approach that many investors associate with hedge funds, but which, in fact, only comprises a small portion of the hedge fund sector. Famous macro investors include George Soros, Paul Tudor Jones and Bruce Kovner. Global macro investors are opportunistic and speculate on the direction of currency, commodity, share and bond prices. The strategy is discretionary in approach, and is normally focused on relative value and value components. Trades are made on the basis of the manager's forecasts of changes, ie interest rate fluctuations, currency movements and liquidity. Macro managers have great flexibility in the instruments they can use and the markets in which they invest, and the strategy tends to be the widest possible mandate available to a hedge fund manager. These funds can be large and often trade the same global trends as other macro funds, as well as proprietary trading desks at major banks.

In the early 1990s, the macro strategy dominated the hedge fund universe, making up some 70% of the assets devoted to hedge funds, according to Hedge Fund Research Inc. Today, Hedge Fund Research estimates the proportion as much lower, making up around 4.4% of the much bigger universe as at the end of the fourth quarter of 2006.

Over the last few years, the overall performance of global macro has been positive. In 2006, the Credit Suisse/Tremont Global Macro Index showed a gain of 13.5%. The same index showed a gain of 9.3% in 2005, and 8.5% in 2004. This does not necessarily reflect the full story amongst the macro funds that are generally available for investment, as shown in the same organisation's Sector Invest Global Macro Index, an investable index, which ended 2006 up 1.2%, and up 0.1% and 2.7% in 2005 and 2004 respectively. The overall performance of the Credit Suisse/Tremont Global Macro Index since its inception in 1994 to the end of December 2006 is shown in Figure 1.


Fluctuating conditions

Macro managers seem to have had a trying first quarter. While many managers had a somewhat positive January, overall, conditions for macro investing were difficult in February, as expectations of Fed action changed throughout the month, and various assets exhibited trend reversals. In addition, signs that the carry trade has started to unwind may pose problems for some managers who have used this to bolster returns. Those managers who produced larger positive returns in February often did so through non-traditional macro positions, such as shorts in sub-prime indices. Anecdotally returns in March were variable.

A number of commentators anticipated a positive year for global macro in 2007, and hedge fund investors surveyed by Deutsche Bank showed two thirds currently owning global macro funds, with one third saying that they would be adding to their positions. The Winter 2006 Tara Capital Hedge Fund Barometer showed a record 63% of respondents saying that they will raise their allocations to macro. The survey is based on the responses of European investors with a total of US$86.5 billion invested in hedge funds. Interestingly, one thought is that this pattern is rather cautious in that, anecdotally, a number of the most seasoned macro managers have taken a fair bit of risk off the table, thereby partially hedging against a market decline.

Overall, however, it has always been rather difficult to read the runes for global macro. In 1999, many commentators predicted the death of macro investing. Subsequently, the strategy has flourished.

Trends are the key

In looking at how the HSBC AIG researches this sector, the main point is that a large part of the view is based on one or more underlying factors it is believed drive the strategy. The HSBC AIG investment team have identified that the main driver for the global macro strategy is the extent to which markets are trending and, particularly, showing relatively clear trends. In order to make money, global macro managers tend to need trends to follow, or to see market dislocations. At the present time, clear trends and dislocations are not so apparent, though there could be potential from rising inflation, causing interest rates to rise higher than expected, or perhaps an economic downturn affecting the record personal debt levels in some countries. This could lead to shifts in some asset prices, and there seem to be opportunities available.

If these drivers do come into play, it is not at all certain that all macro managers will benefit. As the CSFB/Tremont indices above show, there can be great variation in the returns generated by individual funds. Global macro can be one of the highest volatility strategies but it does not correlate closely with other hedge fund strategies. It is therefore a useful holding in many diversified portfolios. However, the disparity in the returns between individual macro funds means that while getting the strategy allocation right is important, it is even more important to select and have capacity with the good managers.