Progress report
An assessment of hedge fund YTD performance in the face of renewed fears for a potential eurozone crash Read More
26/07/2011
Comment: Stephen Oxley
We are all accidental macro traders now” was the way one manager put it at the recent Gaim conference in Monaco. Since 2008, global economics, rather more than idiosyncratic fundamentals, have held sway over the markets.
‘Risk-on; risk-off’ is the cliché that encapsulates the feeling that there is someone up there in the macrocosm randomly flicking a switch that controls the direction of the markets. It can all make it tempting for investment managers who have hitherto focused on the micro affairs of companies (predicting events and earnings, for example) to join in rolling the dice of destiny by making big macro calls.
At times such as these, certain hedge fund strategies tend to become more correlated. We can see this if we compare two strategy groupings that, according to HFR, make up nearly half of hedge fund AuM: event-driven and global macro. The average 24-month rolling correlations between the Credit Suisse Macro and Event-Driven indices has risen from about 0.4 in the years up to 2007 to about 0.6 more recently. What is behind this higher correlation?
A look at some of the holdings of the larger event-driven hedge funds using regulatory filings for the first quarter of 2011 holds some clues. The largest long position held in aggregate is gold. Other top positions among event funds include several energy, mining (more gold) and financial stocks.
Style-drift continues to be anathema to hedge fund investors, and with good reason. Most investors build a portfolio of hedge fund styles, aiming to find managers with diversifying core competencies. If managers place similar concentrated bets, there are two main consequences. First, the risk profile of the portfolio changes (usually beta increases and alpha falls) and, second, managers who were hired to do one thing are now up to something that they may lack the skills and experience to execute successfully.
Textbook event-driven investing aims to isolate price-sensitive, idiosyncratic, corporate events such as M&A, restructuring, bankruptcies and changes in leadership or regulation. Its attraction is having returns that are independent from most market risk factors. Bottom-up, not top-down, factors should dominate the strategy. No manager can ignore the macro environment, but historically the norm has been to be ‘macro aware’, not ‘macro obsessed’. Managers need to appreciate how macro could affect their holdings – interest rates clearly have an influence on financing, regulation on the prospects of financial firms and demand for commodities on the prospects for companies in the supply chain. But the evidence suggests that some managers in the strategy are doing more than prudent hedging of their exposures; they seem to be stretching the definition of an event to include political, global and economic events.
Strategy-hopping is not limited to event-driven managers (some long-short equity managers can be guilty as well) but it is hard not to avoid the suspicion that some, particularly the larger firms, are looking over the wall into macro because they have grown to such a size that it is difficult to find sufficient capacity in the most attractive event trades.
Managers are under enormous pressure to produce returns over relatively short periods and some have had spectacular successes in trading ideas outside of what might be considered their normal remit. So investors have a responsibility too; to understand that there will be times when a particular strategy struggles (by definition a diversified portfolio means some managers will be down when others are up) and to understand the risks being taken by managers in their portfolio, and assess whether these are appropriate.
But macro-trading is a specific skill requiring its own research, timing of trades and portfolio construction techniques. Being an accidental macro trader is one thing but being a deliberate and unqualified one is quite another.
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60 seconds with... Kenneth Turchin
CAN YOU DESCRIBE YOUR CURRENT ROLE?
I have worked in public accounting and hedge funds and in the past eight years have been selling middle- and back-office services to the alternate investment industry. My role is to build relationships with clients, teach them about SS&C’s products and services, and ensure seamless transactions every time the firm launches a new fund.
IF YOU WERE DOWN TO YOUR LAST £1,000, HOW WOULD YOU INVEST IT?
I would buy THREE shares in Apple and hope for a repeat 383% return in the next five years.
WHAT WOULD YOU DO IF YOU WERE IN PRESIDENT OBAMA’S SHOES?
That’s one pair of size 12 shoes I do not want to be in!
WHO WOULD PLAY YOU IF THEY MADE A MOVIE ABOUT YOUR FIRM?
Kevin Bacon. He is a versatile actor and the centre of the entertainment universe. I am in sales. Everyone in the industry would be linked to me in six steps or less. My client list would be ridiculous.
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