Via ConvergEx's Nicholas Colas,
In this month’s installment of our regular series on liquid alternatives, we cover the most popular hedge fund strategy of institutional investors globally: Alternative Global Macro Funds.
These funds capitalize on macroeconomic developments, so the Federal Reserve’s impending decision to hike rates is just one catalyst drawing investors to the strategy. Also known as a “go anywhere” investment style, active managers employ opportunistic trading tactics across asset classes, financial instruments, and geographic regions. Active managers establish positions based on analysis and forecasts of economic cycles, interest rates, commodities, and global capital flows, for example. Representing 30% of the liquid alts universe, global macro funds finished the first half of the year with $137.1 billion in total net assets, up 245% since 2008. Like many liquid alts, global macro funds grew rapidly following the financial crisis as investors looked for strategies that could diversify their portfolios.
The unconstrained nature of the global macro strategy affords these funds the potential to earn positive returns regardless of cycles in the economy and capital markets. Ultimately, success in this classification resides in selecting the right active manager given the strategy’s wide dispersion of returns.
Note from Nick: The original hedge fund, A.W. Jones, dates to 1949 and was a simple long-short equity investment vehicle. It wasn’t until 1970 that George Soros opened the doors on his fund and took hedged investing to the frontiers of practically any and all asset classes. Since then, of course, global macro funds have flourished and today Jessica brings us the latest on how this strategy plays on Main Street through “Liquid Alt” funds. And don’t forget to check out her book on the topic [17]
During a year of heightened capital markets volatility, which hedge fund strategies do you think institutional investors favor? They look to the “hedge” in hedge fund during choppy market conditions, after all. Credit Suisse revealed the answer after polling +200 global institutional investors, representing about $700 billion in hedge fund investments, in its mid-year Hedge Fund Investor Survey. The following includes highlights of the results:
Global Macro (46%) was the most popular investment strategy among institutional investors globally. It was also the top pick in Credit Suisse’s Annual Global Investor Sentiment Survey published in March 2015. The next highest ranking strategy was Event Driven (44%), followed by Equity Long/Short (43%).
The three strategies with the most interest by region include: Americas - Equity Long/Short (56%), Event Driven (47%) and Global Macro (38%); Europe, the Middle East, and Africa (EMEA) - Global Macro (54%), Equity Long/Short (46%) and Event Driven (43%); Asia Pacific (APAC) - Global Macro (44%), Multi-Strategy (44%) and Credit Long/Short (39%).
Ninety-three percent of respondents said that they “plan to maintain or increase hedge fund allocations during the second half of this year”.
In light of the intense attention on monetary policy changes around the world, in particular, it’s no surprise institutional investors largely preferred the Global Macro strategy in the first half of 2015. Pivotal central bank decisions provide opportunities to exploit macroeconomic events, or these funds’ bread and butter. In the liquid alternatives universe – the ’40 Act version of hedge funds where their strategies are wrapped in a mutual fund or ETF – global macro funds have garnered the most assets compared to other strategies in the space, demonstrating broad retail interest as well.
That’s why we chose to focus on the global macro strategy in this month’s edition of our series on the liquid alts asset class. As always, here’s some background information:
Alternative Global Macro Funds employ opportunistic trading strategies by investing in instruments based on inflection points in macroeconomic trends. This may include shifts in political/monetary policy or economic developments, in which portfolio managers analyze and forecast changes in interest rates, inflation, or global capital flows, for example. Investors typically describe these funds as using a “go anywhere” strategy because it is unconstrained in terms of trading a wide range of markets, industry sectors, and geographic regions. They trade various financial instruments – cash, futures, and derivatives asset classes – and go long or short across asset classes – stocks, bonds, currencies, and commodities.
The difficulty in classifying global macro funds, in part, explains the classification’s outsized total net assets compared to the remaining ten liquid alternative strategies as defined by Lipper. With total net assets of $137.1 billion at the end of Q2 2015 according to Lipper, Alternative Global Macro Funds represent 30% of all eleven classifications’ TNA of $462.8 billion.
While Lipper data shows this strategy lost $14 billion in estimated net flows during the first half of this year, total net assets have grown by 36% over the past five years. Additionally, the largest outflows in Q1 and Q2 stem from only a few funds, one of which – PIMCO Unconstrained Bond Fund – lost its high-profile portfolio manager. Another – MainStay Marketfield Fund – used to serve as the poster child for liquid alts, but took a turn for the worst last year after implementing failed inflation based trades.
Like most liquid alt classifications, Alternative Global Macro Funds grew in popularity following the financial crisis. Since 2008, its TNA is up by 245%. Investors typically add exposure to liquid alts as a means to diversify their portfolios since they are supposed to sport low correlations relative to traditional asset classes, such as stocks and bonds. In this sense, the “go anywhere” approach of global macro funds appeal to investors as they can potentially earn positive returns irrespective of cycles in the economy or capital markets.
But have they? The classification as a whole has fared well on average over the long-term, but the variances between funds’ returns are wide. Here’s a breakdown of performance numbers for the first half of 2015 (all data was provided By Lipper):
Alternative Global Macro Funds started the year solidly, gaining 1.7% in the first quarter. This strategy fell 1.5% in the second quarter, however, finishing the first half slightly below the S&P 500’s return: +0.13% versus +0.24% respectively. The average of 5-year annualized returns for this classification is 4.9%, and the average of 10-year annualized returns is a little higher at 5.25%
The five best performing global macro funds earned an average of 11.0% in the first half, while the five worst performing funds declined an average of 7.3%.
Given the wide dispersion of returns, choosing a portfolio manager is essentially the entire challenge of allocating money to this strategy. Increased volatility is by no means a harbinger of positive returns for global macro funds: active managers must make many accurate calls at the right times. Aside from being an expert in the markets they invest, active managers should have a strong investment process and a bulletproof risk management framework. Yes, that is true for any investment manager, but when it comes to global macro the stakes seem to increase exponentially.
In sum, exposure to Alternative Global Macro Funds may prove suitable for investors who want access to its “go-anywhere” strategy in order to capitalize on the macroeconomic events that continue to unfold. These funds may help diversify investors’ portfolios in the midst of volatility in the global marketplace and historically high sector correlations against the S&P 500, thereby improving their risk-return profiles. Ultimately, success with this classification – as with liquid alts in general – depends on an investor’s due diligence when selecting a fund manager.
