Is it easier to predict where Vodafone is heading over the next six to 12 months or what the Bank of England may do with interest rates?
The performance of individual securities is based not only on earning trends and forecasts, but on mercurial investor sentiment toward the related industry, the market as a whole, perception of risk and the current returns of risk-free investments.
Anticipating what Mervyn King, the governor of the Bank, was going to do when interest rates were 5 per cent and the British economy was rapidly sinking into recession, however, was a much easier call to make.
That is the appeal of global macro, a popular hedge fund approach. It is by no means a guaranteed strategy. Markets are inherently volatile and these days government intervention can throw in a monkey wrench that can reverse ostensibly strong trends. But investors can think of it this way: from where can one get a clearer view – on the ground or from 30,000ft above?
Global macro investing is informed by much broader and slower moving trends than those that affect individual securities, such as economic growth rates, inflation, commodity prices, and exchange rates.
Global market strategists search for investment trends across dozens of markets worldwide, including stocks, bonds, commodities, interest rates and currencies. They can go short or long, stacking up positions across asset classes they believe will pay off because of the sequential effects of a given trend, such as inflation or an overvalued market. And they can also establish counter positions to hedge portfolio risk.
As a result, global macro strategies have generated more consistent, profitable returns than virtually all other hedge fund strategies.
Over the three, five and 10-year periods to May 2009, global macro was among the top broad developed market strategies, with annualised returns of 5.50, 6.99 and 9.07 per cent, respectively, according to BarclayHedge, a US-based hedge fund tracking group.
In contrast, the average hedge fund gained only 0.38, 4.84, and 8.54 per cent, respectively over the same periods. The S&P 500 equity index was down 8.24, 1.9, and 1.71 per cent annualised over the three periods. And the MSCI World index lost 9.81, 1.43, and 1.99 per cent annualised over the same time.
Even in last year’s hideous conditions, the performance of global macro funds – down by just 65 basis points – was second only to short bias funds. BarclayHedge’s broad hedge fund index was off 21.63 per cent, the S&P 500 lost 35.31 per cent, and MSCI World Index declined 42.08 per cent in dollar terms.
Global macro funds are run discretionarily or systematically, and some combine both approaches. The former is driven by an investment thesis that informs a basket of trades. If a manager thinks interest rates are expected to rise, for example, he may go long the related currency and short domestic equities.
Systematic trading may inherently be guided by the same considerations. But this approach goes about investing in an automated way, based on intricate algorithms based on years of historical performance that restrict input of sentiment and hunches. Computers monitor and interpret market trends. They ignore theories, only concerned with how markets are moving. And they make investment decisions based on short, medium, and longer term time horizons.
“I don’t believe in efficient markets,” says Rob Friedl, co-founder of Wisconsin-based Fall River Capital, with more than $200m in assets under management. “Markets reflect human nature, and human nature is often wrong.”
He trades across seven distinct markets: agriculture, metals, energy, stock indices, short rates, bonds, and currencies. This gives him access to more than 80 specific trades, ranging from unleaded fuel, wheat and zinc to UK gilts, Euribor rates and the Hang Seng index. And because he can bet them either long or short, Mr Friedl has the potential to perform well in any kind of market. “No one time is any more challenging than another – so long as markets trend,” he says.
Mr Friendl does not care if Opec is cutting oil production or who wins an election. His transactions are focused exclusively on when the price of a commodity, currency, or an index breaks out of a trading range. He will be long if it is going up, short if it is heading lower. And when the trend breaks down, he will get out of the trade.
Since inception in August 2000, his fund has generated annualised returns of 16.17 per cent. In contrast, the S&P 500 was down 3.08 percent over the same period.
Roy Niederhoffer refines the systematic approach, using ultra-short trades to profit from volatility. Last year the R.G. Niederhoffer Capital Management Diversified Program, with $560m (£330m, €389m) in assets, was up 51 per cent.
Since inception in 1993, his average annualised return is 11.1 per cent. But the historically strong trends of this year’s first and second quarter has revealed the one scenario in which he cannot excel. Year-to-date, as of June, he is down 1.19 per cent.
Like Mr Friedl, Mr Niederhoffer ignores company fundamentals and macro-economic trends. With a background in neuroscience he has created computer models that focus on short-term investment biases hard-wired into the human mind.
He explains: “Investors overemphasise recent experience when making decisions; people hate to lose more than they love to win; investors become more predictable as markets become more volatile; and when they are emotional, investors tend to be herd-like in behaviour. That last tendency leads to selling when stocks are near a bottom, and buying when rallies are overextended.”
Mr Niederhoffer endeavours to capitalise on the predictability of these response patterns by targeting quick gains. His Diversified Program makes thousands of trades a year, ranging in duration from several hours to a week, and occasionally longer. Being right just a little more than half the time is all he needs to generate large profits.
Defining the discretionary approach, David Gerstenhaber, manager of the Argonaut Aggressive Global Partnership Fund with $430m, studies macroeconomic data, central bank policies, and government and market data that he maintains in a real-time global proprietary economic database. But unlike some other global macro fund managers, he also drills down into individual market behaviour, searching for value that is not fully reflected in market prices.
“If we don’t have a strong conviction about interest rates or the trend of the S&P 500,” says Mr Gerstenhaber, “we will look at the performance of the oil or aluminium markets to find a more compelling investment,” he says. And he has no problem bulking up in cash if his team of 10 researchers cannot come up with enough strong ideas.
Mr Gerstenhaber’s approach has produced gains every year since the fund opened in 2000, generating annualised returns of 17.6 per cent as of May 2009. Last year he was up 12.3 per cent. Through the first five months of this year, his fund is up nearly 1 per cent.
Daniel Schwartz, the fund’s senior economist, thinks that the modest performance so far this year comes down to this: “If you didn’t believe in the stock market rally, it was hard to buy into the dollar sell-off, the oil rally, or the bond sell-off as well because they all temporarily became highly correlated trades”.
But investors should not misinterpret the lacklustre year global macro is having so far in 2009. Recent big gains of the above managers aside, global macro is not a strategy that gambles on making big killings. That is why, to its credit, it did not get hit by the extreme market moves last year.
“Short-term whipsawing conditions with low directional volatility have been challenging this year,” explains Aref Karim, who runs Quality Capital Management’s $666m Global Diversified Programme, which has generated annualised returns since 1995 of 15.82 per cent. In 2008, he was up 60 per cent.
“We best profit from longer term, sustainable macro trends in which we have a higher degree of conviction,” says Mr Karim.
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