Many moons ago (in the early 90’s) I was a plain vanilla discretionary macro trader/PM. In those days there weren’t very many of us and we came from the fixed income / foreign exchange side of the business. We hunted for mismatches between central bank policy, and inflation and GDP growth. Since central banks can be rather slow moving sometimes, one could find moments when you could trade ahead of inevitable policy changes.
The equity departments at such firms as Tiger, Omega, Soros and Steinhardt had a different and usually separate mandate. Yes, the scions of those firms could and did take extra size longs and periodic shorts in S&P futures, but their preference was to trade stocks mainly from the long side and look for good relative value. If they had a strong view about radical changes in GDP, bets would be made on bonds or the dollar but rarely on the S&P.
As global macro grew into a conventional component of large hedge funds, more PM’s were hired and they almost all came from the fixed income or foreign exchange side of the business. Over the next twenty years, these people honed their central bank tracking skills to the point of parsing the verbiage of Fed and ECB minutes. The proof that such skills are (now) valueless is revealed every month by the returns of Global Macro hedge funds. It’s not their fault – we are all slaves to volatility and the only volatile assets are:
- Long bonds
- The Yield Curve (30’s vs 5’s)
- Stock Index Futures
- Equity Index Spreads
- Risk Parity
Let’s look at some historical data:
In the upper plot of the chart, we can see price volatility for US 2 yr. notes and the Euro. You can see how much lower they both are compared to the ’06-’09 period. “Of course they are lower”, you say – it was a wild world in ’08-’09, Perhaps I’m not being fair. The lower plot shows the volatility of Risk Parity and the S&P (vs.) Nasdaq spread. They are both just as volatile as they have ever been. If we go back to the 90’s the comparisons are even starker.
To make money we simply must trade the most liquid, volatile assets. If we don’t, we will paint ourselves into a tiny corner praying for an inflation shock or Grexit.
“But beating the stock market is not my job” – you say. Everywhere you look you find irritated investors. They are unhappy about three things:
- Poor absolute returns
- High fees, especially compared to returns
- Poor relative returns compared to low-cost equity index funds
Global Macro can lower its fees, or it can try to capture some of that equity market upside. These firms don’t have to maintain a permanently long position but never owning any equities is no different from being relentlessly bearish. We all appreciate the argument for an uncorrelated return series. If I am always bullish then my returns will correlate so highly with the S&P that funders will rightly ask – “Why don’t I just buy a low fee S&P 500 index?” The answer has been – “because we have a method that will protect us/you from market weakness.”
Such a method has costs. It will likely mean that you will not be able to capture all the upside so you can’t overpromise but to say that you will miss all of the upside (or volatility) of the 3rd largest asset class is unacceptable. After 8 years, investors have forgotten the gains hedge funds made in ’08 when stocks crashed.
What should a CIO do? Hire some global macro equity traders (not stock pickers). Include some trend following and mean reversion approaches to operate on index futures and on spreads between equity indices. If you have a plan for how to capture equity market upside, then you may well end up with a plan for capturing downside as well. We have reached a point where investors see their opportunity cost not as the risk-free rate but a blend of that rate and the return of the S&P 500. Even if institutions say they don’t care about equity returns, their bosses are noticing the spread and remembering the Buffet bet from 10 years ago. A tactical approach to trading equity futures is marketable as such, not as a passive hedge against superior index fund returns.
There two simple undeniable truths:
- Lower GDP volatility and lower volatility of GDP differences are here to stay
- A global labor glut will persist and won’t provide the normal amount of wage beta vis a vis unemployment
The old world of central bank policy volatility will not return anytime soon. If there is less variance of GDP performance between countries, then there must be less currency volatility. What will be the shock that will change this situation? A radical change in trade policy might do it but few leaders are entertaining such a change – including Donald Trump. Even if we do get a shock like a war with North Korea, bond yields are so low that the best position most likely will be a short in equities rather than a long bond position.
Global Macro needs a boost not from markets per se but from their CIO’s approach to what markets they are willing to trade.