This article was first published in Pensions & Investments on 6th May 2024 here.
Even as the U.S. Federal Reserve and other central banks prioritize getting inflation under control, which sets the stage for lower interest rates, institutional investors face no shortage of ongoing global macroeconomic and geopolitical issues that can keep capital markets — and investment portfolios — volatile.
That’s one reason why a global macro strategy can — and should — play a role in institutional portfolios. Not only can it provide juice to a portfolio during periods of market uncertainty, it can also offer a steady anchor to other investment strategies when times are relatively stable. Viewed as such, global macro can be a useful strategy for all types of institutional investors.
“Allocators should consider macro strategies as an important addition to their portfolios,” said Christian Dery, head of macro strategy at Capital Fund Management (CFM), a global quantitative and systematic asset management firm. “First, it can be a consistent source of return and diversification; and second, it can generate insights for other areas of the portfolio exposed to macro risks.”
Those insights are critical, because all asset allocations — equity and bonds, alternatives buckets, real assets — face macro risks.
Global macro seeks to understand specific scenarios — whether economic, political, regulatory or other factors — that will affect financial assets, and it considers all asset classes and geographies to take advantage of those scenarios.
“The opportunity set spans a broad range of liquid asset classes — including foreign exchange, equities, rates, credit and commodities — with the ability to position long or short across the world to construct uncorrelated and diversified strategies,” said Dery.
Understand wider impacts
“You can think of macro as a strategy that eventually impacts all strategies,” he said. Dery pointed to 2022, when equity long-short strategies underperformed as central banks aggressively ratcheted up interest rates to combat inflation. Many macro investors understand this playbook well and positioned successfully in 2022. Other strategies would have benefitted from a deeper understanding of emerging macro risks.
“For long-term investors with buy-and-hold portfolios, 2022 was a perfect example of macro impacting passive-investment portfolios,” he said. “Inflation and the Fed’s appropriate response caused both stocks and bonds to underperform, breaking the flight-to-quality properties of safe bond portfolios.”
“Not paying attention to the macro environment introduces unnecessary tail risk into strategies,” Dery said. Even strategies that appear market neutral will eventually flash macro biases, he added. For that reason, understanding the role that macro strategies can play is “critical” for all types of investors in order to better understand changing economic trends and their impact on markets and portfolios.
Systematic framework
The two foremost global macro strategies are systematic and discretionary. It’s important for investors to understand their key differences. Systematic funds follow rules-based strategies, while discretionary funds rely on managers to make day-to-day investment decisions.
The two approaches have generated complementary performance patterns over various market environments, but the systematic approach can provide better comparative returns and broader diversification by leveraging significantly more data, computing and technology to test ideas and invest in a wider range of instruments and markets.
Another major difference is cost. “Discretionary traders will have competent execution desks,” but as assets under management grow, trades and positions become larger, which can make it more difficult to control transaction costs, he said.
“At CFM, we dedicate significant research and technology resources to understanding transaction costs,” he added. “Investors forget that transaction costs are the largest cost in strategy implementation, higher than fees paid to access strategies. We store a terabyte of tick data daily and have a database of over 250 million executed trades. This information automatically feeds back into our investment processes and improves execution costs on an ongoing basis.”
“Discretionary funds might not be doing this as effectively, leading to performance leakage,” Dery said.
Another key difference is around diversification. Discretionary global macro portfolios tend to be concentrated, making them potentially riskier than a systematic global macro portfolio. And the bigger the discretionary portfolio, the greater the concentration as human risk takers are forced into a narrow set of liquid contracts to express a small number of investment ideas, Dery explained.
“Because it trades many more instruments globally, a systematic approach achieves significantly more diversity, not only in markets traded but also in the source of ideas,” he said.
“There are certain opportunities which are impossible for a human to capitalize on. For example, small, statistically significant opportunities that decay quickly can only be captured with a platform that has achieved a critical technological scale. It turns out that adding up many of these small but statistically significant effects results in high-performing portfolios.”
Human input
Another major factor that sets systematic global macro apart from discretionary is the human factor.
“Our research process is a form of scientific discovery in which numerous ideas are generated and assessed,” Dery said. “The ability to ideate is only limited by the number of researchers and their creativity, the availability of data and our technology stack. Significant investment in these areas has allowed us to achieve scale.”
“A systematic approach is ruthless. It never sleeps, has no emotions and is continuously adapting,” Dery said. “A human trader might get tired or be having a bad day. This can lead to bad decision making and potentially inferior trades. Ultimately, this will leak into performance.”
But that doesn’t mean that every risk can be captured in a model. “The primary function of our market risk group is to identify emerging risks and determine how they will affect our strategies. As a quantitative manager, we rarely override models but in highly uncertain scenarios, we can reduce our overall exposure to an emerging risk.”
Three-pillar foundation
CFM’s global macro strategy is built on three pillars: research, portfolio construction and execution. The firm uses a quantitative, data-driven approach to identify macro trends and attractive investments related to those trends. The strategy is systematically implemented across a diversified range of financial instruments and asset classes.
The firm not only has a dedicated global macro fund, but it also applies the same scientific approach for its other strategies. The process involves sourcing and analyzing data to create new investment insights and ideas, testing those ideas, validating them and building them into portfolios.
“The research platform allows us to scale and rapidly evaluate insights to determine if they add value to our strategies. The platform determines whether an insight adds new or statistically valid information to our portfolios or not.”
Agility across scenarios
One of the benefits of a global macro approach is the ability to modify positions quickly, including the critical function of being able to identify and react to major economic, geopolitical or policy changes, he said. This is especially true in periods marked by higher levels of uncertainty, when a global macro manager needs to stay agile to assess the pace and flow of data.
Even the most diverse investors — those allocating significantly to hedge funds at one end and those employing buy-and-hold strategies at the other — face ongoing risks that will impact their investment portfolios. That’s where a global macro strategy can make a difference.
“Adaptive statistical approaches are codified into our models and strategies,” Dery said. “This allows us to detect and react to regime changes quickly.”
“We live in a complex world that is continuously changing.” For example, the last few years have featured rising interest rates, elevated inflation and increased geopolitical risks. The investment environment so far in 2024 has been characterized by uncertainty around the timing of central banks’ next moves, improving economic indicators and a raft of geopolitical hotspots.
“Through a combination of insights generated from our strategies and our deep bench of experienced researchers, we strive to stay in front of key macro risks,” he added. “Investors can benefit from these insights as well to help them better understand embedded risks in their own portfolios.”
“Macro strategies can always find interesting investment opportunities irrespective of the environment,” Dery said.
DISCLAIMER
ANY DESCRIPTION OR INFORMATION INVOLVING MODES, INVESTMENT PROCESSES OR ALLOCATIONS IS PROVIDED FOR ILLUSTRATIVE PURPOSES ONLY AND DOES NOT CONSTITUTE INVESTMENT ADVICE NOR AN OFFER OR SOLLICITATION TO SUBSCRIBE FOR ANY SECURITY OR INTEREST. ANY STATEMENTS REGARDING CORRELATIONS OR MODES OR OTHER SIMILAR BEHAVIORS CONSTITUTE ONLY SUBJECTIVE VIEWS, ARE BASED UPON REASONABLE EXPECTATIONS OR BELIEFS, AND SHOULD NOT BE RELIED ON. ALL STATEMENTS HEREIN ARE SUBJECT TO CHANGE DUE TO A VARIETY OF FACTORS INCLUDING FLUCTUATING MARKET CONDITIONS AND INVOLVE INHERENT RISKS AND UNCERTAINTIES BOTH GENERIC AND SPECIFIC, MANY OF WHICH CANNOT BE PREDICTED OR QUANTIFIED AND ARE BEYOND CFM’S CONTROL. FUTURE EVIDENCE AND ACTUAL RESULTS OR PERFORMANCE COULD DIFFER MATERIALLY FROM THE INFORMATION SET FORTH IN, CONTEMPLATED BY OR UNDERLYING THE STATEMENTS HEREIN. CFM ACCEPTS NO LIABILITY FOR ANY INACCURATE, INCOMPLETE OR OMITTED INFORMATION OF ANY KIND OR ANY LOSSES CAUSED BY USING THIS INFORMATION. CFM DOES NOT GIVE ANY REPRESENTATION OR WARRANTY AS TO THE RELIABILITY OR ACCURACY OF THE INFORMATION CONTAINED IN THIS DOCUMENT.
