Andre Breedt, Capital Fund Management
Global equity markets enjoyed yet another tidy rally in 2021. In the US, the S&P500 TR Index returned 28.7% – marking seven years of double-digit growth over the past 10. Meanwhile, in South Africa, the FTSE/JSE Capped SWIX All Share Index managed 22.3% in rand terms. Global beta exposure was, as such, a very lucrative and popular strategy.
However, many of the same dynamics that have supported the post-GFC (global financial crisis) rally in equities are looking less of a sure thing. For one, persistent inflation is set to push up interest rates, with real rates becoming unanchored from a protracted decline – a feature that has hitherto helped to prop up asset prices. Equity valuations, especially in the US, are also looking stretched by nearly any metric one cares to consider, while many equity indices have come to be dominated by a handful of mega-cap technology stocks, exposing investors to greater levels of concentration risk.
Furthermore, companies, owing to a significant demand-shock following massive fiscal and monetary stimulus post-Covid, have been successful at passing on higher prices to consumers. There is, however, no guarantee that these levels of excess demand will persist, or that corporate profits will remain high especially given (likely) higher labour and energy costs dragging on margins.
Investors are, in addition, likely to wrangle with a myriad of uncertainties in 2022 and beyond, all likely to elicit higher levels of volatility: Covid, geopolitical risks, rising energy prices, policies in tackling climate change, as well as the US mid-term elections (with uncertainty about the timing and successful promulgation of various pieces of legislation, not least the ‘Build Back Better Act). The only certainty in 2022 is said to be uncertainty.
All of this begs the question whether investors can reasonably expect the performance of equity markets to persist. Broad consensus says no.
Equity returns are expected to average only about 4.1% over the next 10 years (footnote 1) and, with yields hovering around record lows to boot, many investors are looking to alternatives for returns.
We believe, given capital markets’ particular sensitivity to macroeconomic events today, that global macro strategies should be considered as a diversifier.
In fact, opportunities for macro strategies have already grown as a result of the inherent disequilibrium in markets, sparked most recently by the Covid crisis. Macro strategies, then, with the ability to invest across multiple sectors and instruments, are well-poised to capitalise on the current market environment given the many sources of uncertainty, this set against a backdrop of high asset valuations (and arguably some market complacency).
Here we hope to shed more light on what global macro strategies are, show the benefits of a systematic approach, and argue – given that these strategies offer a high level of diversification, while boasting a long track record of delivering attractive levels of risk-adjusted returns – that they are a good complement not only to any existing asset allocation, but also to an existing hedge fund allocation.
WHAT IS GLOBAL MACRO?
Pinpointing one single definition of ‘global macro’ is tricky given the wide range of manager styles, most of which target different time horizons, with many different inputs being employed to make investment decisions.
Nonetheless, global macro strategies, broadly speaking, represent a highly opportunistic investment style centered around the interpretation of macroeconomic events on a national, regional, and/or global scale.
These events, which can be triggered by a myriad of forces including shifts in government policies, politics, central bank intervention or even idiosyncratic crises, can, and do, impact financial markets.
Moreover, these strategies commonly take positions across a wide range of markets and a comprehensive set of asset classes. Below we highlight the common characteristics and benefits of global macro strategies.
I. Capturing shifting market dynamics and fundamental factors
Global capital markets are subject to a litany of catalysts that may manifest in any typical economic cycle. Today, market participants all jostle to make sense of a complex, unprecedented macro environment, which presents with price volatility and no shortage of market-moving risks, especially central bank policy missteps; rising debt levels; continuing tensions in the Middle East; ongoing trade wars; an increasingly assertive Chinese Communist Party; a slowdown in globalisation; a continued rise in the sharing economy; ageing populations; and populist politics to name but a few. In summary, there is no shortage of sources of risk, with all having the potential to alter market dynamics, generate heightened levels of volatility and adjust expected returns across all asset classes.
A global macro strategy can opportunistically, and reactively, exploit patterns to both protect and profit from shifts in the market triggered by any one, or combination of, these idiosyncratic events.
The investment process of macro strategies is therefore predicated on capitalising on movements in underlying economic
variables and the impact these have on equity, fixed income, currency and commodity markets.
Moreover, global macro strategies are designed to exploit market inefficiencies, such as investor biases that manifest during different periods of macroeconomic cycles and market activities.
To capture these effects, global macro strategies have:
1. The ability to trade across an extensive range of financial market instruments – equities and fixed income are the obvious candidates, but also credit, currencies and commodities. The latter asset classes offer increased diversifi cation potential via instruments less commonly traded by typical practitioners.
2. The ability to take both long and short positions across this universe and adapt the positions dynamically to seek performance throughout market cycles.
II. Performance throughout various market environments
The innate characteristics of global macro investing, along with the opportunistic attitude of global macro managers, have proven resilient in various economic environments. Few asset classes or investment strategies have delivered such consistent returns through various business or economic cycles.
Figure 1 illustrates the performance of global macro hedge fund indices showing performance across multiple business cycles that feature accelerating and decelerating inflationary and growth environments.
With uncertainty as to the dynamics of any business cycle (especially now, post-Covid, with uncertainty about near-term economic growth), bonds, previously, could always be called upon to act as steadfast diversifiers.
However, while bonds acted as the must-have diversifier in investor portfolios, the fear of inflation (and inflation expectations) and the noticeable shift in the correlation between bond and equity returns having become less negative (even flipping into positive territory in the case of the US – see figure 2), puts traditional 60:40-like portfolios at risk (footnote 3). Investors who customarily rely on bonds to hedge against equity drawdown are forced to look for alternatives, and macro strategies, with the ability to capture global effects, are viable contenders.
CAN GLOBAL MACRO STRATEGIES BE SYSTEMATISED? AND WHAT ARE THE BENEFITS?
When it comes to macro strategies, investors tend to be more familiar with traditional ‘discretionary’ funds, where managers use fundamental analyses on specific markets to trade individual securities.
Systematic strategies, while not completely novel to investors – after all, rule-based trading approaches emerged as early as the 1950s – gained greater notoriety in recent years with the rise of electronic trading coupled with big data and substantial progress in advanced learning techniques.
Nevertheless, systematic strategies are frequently – sometimes inappropriately – considered as mysterious ‘black boxes’ whose mechanisms to generate returns remain vague.
However, while specific macro models can be rather complex, most rely on conceptually intuitive ideas. In reality, systematic strategies aim to replicate the investment process of a discretionary process in a manner that is robust and scalable. Long and short positions are derived from models which themselves stem from the understanding derived by human analyses, but with the benefit of leveraging the strengths of algorithms, some highlighted below.
I. Broader universe
Systematic investing offers significant economies of scale. A winning strategy on a specific underlying can be tested and replicated almost immediately across a wide and diversified set of underlying instruments. While a discretionary manager typically focuses his/her expertise on ‘big’ macro themes, systematic portfolios typically explore a wider trading universe, across multiple asset classes and geographies, pushing the boundaries beyond mainstream asset classes and contracts. A systematic global macro portfolio is designed to identify a broad set of inefficiencies, and can trade in hundreds of markets, ranging from traditional equity indices (S&P 500, Eurostoxx, FTSE China, etc.) to more exotic contracts including e.g. orange juice, lean hogs or the Israeli shekel.
II. Rigorous and emotionless process
Like any human being, investors exhibit emotional biases. Anxiety, stress, fatigue and even happiness are a few examples among many psychological factors that have been shown to influence the decision-making process (footnote 4). These emotions may favour suboptimal reactions that make investors unconsciously diverge from an initial set of rational objectives. Algorithms are immune to these effects and respond identically with the same inputs. Their response will only vary given a change in the underlying data on which they have been designed and trained. The stability and consistency provided by this mechanical, rule-based approach is essential to capture subtle statistical effects on large scales.
III. Ability to track and integrate a wide set of informational inputs
Information and data have always been at the core of macro-driven strategies. But the exponential increase of data (and ‘alternative’ data) – whether derived from markets, news or media – makes it incredibly challenging, not to say impossible, for a traditional one-man analyst to digest all relevant information without the support of technology.
Algorithms, on the other hand, are tireless workers continuously connected to multiple data sources with the ability to quickly track and digest gigabytes of data.
The rise of quantitative/systematic strategies is a natural response to our more-than-ever fully connected world and may also explain why some discretionary managers are complementing their process with a systematic approach.
IV. Rise of dynamic learning techniques to better adapt to changes in market conditions
Data is essential but not sufficient. The success of macro strategies has often relied on the ability of managers to correctly anticipate key changes in market environments. Rule-based approaches, which leverage past historical analyses and rely on a consistent view of historical relationships between fundamentals and prices, seem, at first, less able to adapt to previously unseen regime shifts. Discretionary managers, including discretionary macro managers, might have an edge, being able to form new expectations based on sudden regime shifts, or when markets change suddenly.
However, recent and ongoing developments in computer science introduced self-learning algorithms, capable of adjusting themselves without external intervention. Dynamic learning derives from this approach and allows models to modify their own parameters “on the fly” as new data is fed into the system to better adapt to new market conditions.
V. Low key-man risk
Lines of code are easily transferrable and remain the property of the manager, thus reducing the impact of any departure. In fact, developing, testing and maintaining models requires a collective framework where information is shared across several teams. Contrarily, discretionary macro funds are exposed to higher keyman risk as their investment process relies on the fund manager or at most, a few individuals.
VI. Low correlation with key benchmark asset classes (and other hedge fund strategies)
The diversity and heterogeneity brought about by the use of algorithms provides systematic macro strategies with extra diversification potential beyond traditional discretionary macro portfolios and key benchmark asset classes. For investors wanting to diversify away from equity risk, few options are available since most asset classes, except for sovereign fixed income and certain alternatives, contain an equity risk premium. Figure 3 (below) shows the cross-correlation of macro strategies and key benchmark asset classes, showing that macro strategies, on average, feature low correlation not only to most key asset classes, but also hedge funds on aggregate. Moreover, systematic and discretionary global macro strategies can be viewed as complementary, owing to the low correlation between them.
After years of stellar equity beta returns, investors are justifiably anxious about continued equity market performance – typically the biggest exposure in most institutional portfolios.
Not only have we witnessed an increased correlation of many hedge fund strategies to traditional asset classes, but markets are grappling with stretched equity valuations, low yields, and no shortage of uncertainty.
Global macro strategies are well-poised to navigate these markets, with not only demonstrable low correlation to most traditional asset classes, but the ability to profit from several emerging ‘macro themes’. Many of these, such as squeezed corporate profits owing to higher structural cost; a rise in anti-globalisation sentiment; higher inflation; disequilibrium in the energy supply-demand dynamics; and a global effort to reduce climate change amongst others; are all likely to be highly disruptive and, as such, present multiple opportunities for global macro strategies to monetise.
Global macro strategies are designed to exploit, systematically, shifts in global markets while offering protection against equity drawdowns, and have proven to offer attractive risk-adjusted returns through various economic cycles. Given all these benefits and given the current environment, we believe investors would be well-advised to consider a systematic macro strategy as an addition to their portfolio mix. Copyright. HedgeNews Africa – January 2022.
Andre is a member of the research team at Capital Fund Management (CFM), a quantitative systematic hedge fund founded in 1991, headquartered in Paris, with offi ces in London, New York and Sydney. CFM manages a large set of quantitative strategies, trading a priori liquid instruments including futures, equities, bonds, options, and spot and forward FX. CFM manages approximately $8.3 billion as of 31 December 2021, with 120 institutional investors across the globe. Andre holds a BCom Law from the University of Pretoria as well as an MSc (Economics) and MPhil (Economics), both from the Sorbonne in Paris. Prior to joining CFM, he worked for the United Nations and Deutsche Bank in New York, as well as Societe Generale in Paris. Andre holds dual South African and French citizenship. www.cfm.fr.
 Long-Term Capital Market Assumptions, 2022, 26th Edition, JP Morgan
 We identify each of the four regimes in this quadrant model by using the sign of a four-quarter minus a 20-quarter trend in order to detect whether the two macroeconomic variables, GDP and inflation, are ‘accelerating’ or ‘decelerating’. (Please refer to our paper ‘On business cycles… and when trend following works’ for a detailed explanation of our alternative approach to identifying business cycles.) The Sharpe ratio of each individual macro index is evaluated over its total available history.
 Please refer to our discussion note ‘Bond equity correlations: are the times a-changin’?’
 There exist a broad and rich literature on behavioural drivers that influence the investment decision process. Readers might want to consider referring to an excellent paper by two pioneers in the field of behavioural economics: Judgment under Uncertainty: Heuristics and Biases. Amos Tversky; Daniel Kahneman. Science, New Series, Vol. 185, No. 4157. (Sep. 27, 1974), pp. 1124-1131
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