Global macro is both a distinct hedge fund category and a trading strategy used by many hedge fund managers. It features a low correlation to other asset classes, low volatility and smaller drawdowns. For these and other reasons, it’s highly popular among investors.
What is global macro?
Global macro is usually based on a top-down or a bottom-up approach. In the case of the former, the hedge fund manager first analyzes the global economy and then drills down to different countries, regions and asset classes in order to develop an investment idea. Global macro offers the largest (if not the largest) universe of fully investable ideas and the opportunity to trade any available asset in the world. The only limitation for many funds is liquidity.
The focus is on equity indexes, currencies, government bonds, interest rates and commodities. Investments are made through direct ownership of the underlying, particularly in the case of equities and bonds, or through derivatives such as options and futures.
Global macro categories
Generally speaking, global macro can be divided into two categories:
Discretionary means that the hedge fund is run by a single portfolio manager or a team of managers who implement investment decisions using their own judgment. These decisions are generated by economic research and fundamental data and, if necessary, are expanded to include technical factors.
Approaches and strategies
Global macro encompasses various approaches and strategies. In the following, I’d like to describe the most popular approaches so that you can get a better understanding of performance and risk factors.
Relative value/perceived arbitrage
This approach can be seen in many global macro portfolios. Relative value implies the simultaneous buying and selling of an asset pair, also known as pairs trading. Here traders bet on a spread either narrowing (convergence trade) or widening (dispersion trade).
There are many possible relative value trades with differing objectives. For example, traders can go long one sector and short the overall market based on the expectation that the individual sector will outperform the market.
They might also take a long position in a two-year government bond and short the ten-year government bond of the same country. With such intra-curve value trades, they profit from the rise in the yield curve.
Although the basic principle remains similar, the trades themselves may differ depending on whether they’re based on a top-down or bottom-up approach. Global macro hedge funds may, for instance, implement relative value trades with a top-down approach by trading one country’s stock index against another country’s index, or by trading one country’s currency against another country’s currency. A bottom-up approach would involve, say, trading the corporate bond of an American company relative to a US government bond with a different maturity.
Under normal market conditions, directional trades normally account for a small part of global macro portfolios, but in turbulent times or crises, they can represent the majority of all positions. As with relative value trades, the underlying assumption is that assets are overvalued or undervalued. In contrast to relative value, though, portfolio managers only take outright long or short positions. “Outright” means that the position is unhedged – i.e. managers don’t enter into an additional position to offset risk. Relative value always has to do with the valuation of two assets. Directional/mean reversion, by contrast, focuses on one asset, which is traded on its own. However, the underlying logic is the same.
After developing an investment thesis (e.g. identifying a mispricing in the market or a significant change in market structure), global macro managers buy or sell the respective asset outright in order to bet on a movement back to the average historical price or to fair value.
Many prominent global macro managers have become famous by successfully implementing such trades and generating enormous profits for their hedge funds. The best-known example is probably George Soros, who shorted the British pound, which he expected to depreciate significantly. This trade ultimately forced the United Kingdom to leave the European Exchange Rate Mechanism, the precursor to the euro. Another famous example is Paul Tudor Jones, who correctly predicted Black Monday of 1987 and made money by shorting the US stock market.
To sum up, relative value trades tend to be market neutral, whereas discretionary trades tend to carry a higher market risk. Hedge fund managers who take the discretionary approach are prepared to take this risk.
This is a global macro approach that is similar in many ways to the relative value strategy as it also involves trading two assets against each other. However, it is not based on a mispricing of the assets relative to each other, but on profiting from different interest rates in their respective currencies. Traders might, for example, short the currency of a country with low interest rates (e.g. Japan) and go long the currency of a country with higher interest rates (e.g. Australia). There are two possibilities: either traders benefit from the spread of the two currencies, or they bet on a widening of the spread (which is more applicable to global macro managers). In other words, traders speculate on the appreciation of the currency they’ve bought against the currency they’ve sold.
Another option is reverse currency trades. Here a manager shorts the currency with the higher interest rates and goes long the currency with the lower interest rates – based on the expectation that the spread and the interest rate differentials will narrow.
The risk is that the expected relationship reverses. Because carry trades often involve high leverage, they’re associated with higher risk.
This approach has and continues to be a core factor in the performance of many systematic global macro funds. However, it’s also used by numerous discretionary funds. Its practitioners buy past winners and sell past losers based on the expectation that the winners will continue to perform well in the future, while the losers will continue to perform poorly. This strategy can be applied to all asset classes, but it is most popular among traders of commodities, currencies and equity index futures.
The strategy can also be implemented in different time frames, whether short, medium and long term. Here “short term” means anywhere from a few hours to just under a month. “Medium term,” which is the most common time frame, means one to six months. Anything beyond six months is considered long term. Naturally, this approach performs best in trend phases and can lead to problems when a trend reverses. In addition, especially in trendless markets, spikes in volatility can force fund managers to close positions, leading to losses and high transaction costs.
Conclusion of this brief description of global macro
Global macro is highly popular among hedge funds – and rightly so. It provides numerous opportunities to participate in price fluctuations, trends and mispricings. It also offers the largest universe of investments and thus many investment possibilities.
The best performance can be achieved in volatile phases. Featuring low correlation and risk, global macro strategies make it possible to generate stable performance over the long term. Investors looking for a broadly diversified portfolio with low risk will find much to like about global macro.
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