Implementation considerations within discretionary global macro
By Josh Palmer, Senior Investment Analyst, Willis Towers Watson
Published: 31 March 2016
Perhaps in contrast to other investment strategies, discretionary global macro (“macro”) managers cannot be easily categorised into homogeneous groups. Macro funds will vary by a number of characteristics, including but not exclusive to, asset-class focus, geographical focus, trading style (thematic versus idiosyncratic), investment horizon and structuring sophistication. The focus for a particular manager will of course be influenced by the skill set and experience of the portfolio managers and their team.
The result is that the portfolio manager will approach the markets in their own specific style and each fund will be an organic aggregation of its specific underlying discretionary views and subsequent investments. This, coupled with the significant breadth of macro trading, results in differentiated funds, even within sub-sets of macro – such as developed markets (DM) macro. This is reinforced by the typically low, long-term correlations between macro funds, as well as macro in general, and other hedge fund strategies and market betas. As a result, we believe that macro managers warrant a long-term strategic allocation within investors’ portfolios.
In what follows, we discuss the implementation options available within macro to investors. We start with DM macro and analyse how this sub-strategy has been impacted by the market environment in the past few years. We then argue why the outlook for DM macro appears to be improving and outline how the opportunity set may evolve. Later we discuss emerging market (EM) macro and the evolution of the manager line-up and opportunity set here. We finish by considering how, for higher governance investors, an allocation to EM macro could supplement that of DM global macro.
The case for DM macro
As alluded to above, we believe that macro managers warrant a long-term strategic allocation within investors’ portfolios. The strategy provides diversification through low long-term correlations with other strategies and asset classes, it tends to profit in times of rising uncertainty and volatility (due to a structural long volatility bias), and provides significant exposure to skill premia rather and bulk-market betas.
Historically, allocations to macro have been tilted to DM for several reasons. First, there are a large number of managers with a DM focus possessing strong and long track records. Second, the size and depth of liquidity in DM markets create an attractive opportunity set by allowing for the flexibility to react quickly as market drivers change in real-time and macro-economic trends play out. Third, there has been a large amount of investor appetite for such strategies historically aimed at diversifying away from DM bulk betas. Last, DM managers were well established and large and presented much less business risk than EM managers that were generally still finding their feet.
However, DM macro has not fared too well in recent years. Part of the reason for the strategy’s underwhelming returns has been the protracted period of quantitative easing and coordinated central bank policy setting across the developed world. This has vastly reduced the opportunity set by anchoring current interest rates close to zero and subsequently reducing uncertainty in the interest-rate-futures market. This has weighed on performance through the reduction in directional and arbitrage opportunities, as well as the payoff to trades due to supressed volatility.
It was difficult to predict the extended duration of central bank co-ordination. However, we are now seeing a significant improvement in the opportunity set in the form of so-called policy divergence. Indeed, the Federal Reserve has embarked on its first interest rate hike in nearly a decade, while the Bank of Japan (BoJ) and European Central Bank (ECB) defy the lower bound for interest rates. These opposing monetary policies have created an attractive divergence trade for DM macro managers to capture as it develops. Furthermore, this divergence of monetary policy is unlikely to be smooth, despite attempts to provide forward guidance- which currently many market participants feel resembles forward deception. This will further enhance the opportunities for DM macro managers who should be able to profit from their insight, structuring skills and broad tool kit across asset classes.
In conclusion, the outlook for DM macro appears to be improving as the opportunity set evolves. With the benefit of hindsight, an allocation to DM macro would not have been the best decision over the last three years, however now is not the time to cut exposure.
The case for EM macro
An allocation to EM macro could also be considered by high governance investors as a supplement to their existing (likely DM) macro allocation. The emerging markets are becoming increasingly institutionalised and liquid, becoming more suitable for a discretionary macro strategy since this allows for the flexibility to react quickly as market drivers change in real time and macro-economic trends play out. In addition, the broadening and deepening of capital markets allows for more sophistication in trade expression.
However the most salient benefit of supplementing DM with EM macro is diversification. Given their differing, and increasingly broad, opportunity sets and the heterogeneity within EM itself, it is much less likely that both will suffer from the same headwinds such as developed world central bank policy coordination. Even if this were the case – some EM economies are actually cutting interest rates – there are greater inefficiencies in EM as a result of less coverage from investment banks, less focus from investors and less capital chasing the opportunities.
There are issues, however, associated with investing in emerging markets, such as the availability and quality of information, communication barriers and market regulations. Therefore we feel it is clear that having a specialist immersed in these economies is critical in order to capitalise on the alpha opportunities and to obtain an edge.
To summarise, emerging markets offer a ripe opportunity set due to their scale, diversity and generally desynchronised business cycles and policy frameworks. However investing in this opportunity set comes with many issues that need to be understood so as to mitigate risk and capitalise on opportunities. Therefore, for an investment in EM macro, we recommend hiring a specialist manager who is immersed in these economies and possesses the requisite skill set.
Discretionary macro manager implementation considerations
As discussed, each macro fund is the organic aggregation of its underlying discretionary, opportunistic investments which will be influenced by the particular skill set and experience of the portfolio managers and their team. So simply having one DM focused manager does not necessarily provide exposure to all of the opportunity set within DM. Similarly, having exposure to a single EM macro manager will not provide exposure to all emerging markets.
For higher governance clients, an allocation to EM macro could supplement an allocation to DM global macro. As has been argued throughout, DM and EM macro managers possess very different skill sets and experiences which are required in order to capitalise on their respective opportunity sets. In times of central bank policy coordination in developed markets, the EM macro funds can provide alternative return drivers. Conversely, the lift-off from zero rates in the US combined with the ECB and BOJ’s ongoing battle with deflation is an opportunity not to be missed.