“These Strategies Just Aren’t Working Anymore” – A Simple Explanation For Underperformance

We’ve documented the recent trials and tribulations for macro hedge funds extensively this year. Remember this?… “What You Got Was The Exact Opposite”: Macro Hedge Funds Join The “Dumb” Money

You should read it. Or not. Whatever.

Anyway, the simple fact of the matter is those funds are having a rough go of it. Here’s an amusing bit from a recent Reuters article that predicts an imminent “revival”:

Macro funds bet on macroeconomic trends using currencies, bonds, rates and stock futures. They outperformed the broader industry during the financial crisis and amassed tens of billions of dollars between 2010 and 2012. But they lost most of those assets between 2013 and 2014 and also in 2016 for a variety of reasons, including performance.

Yes, “including performance.” That classic “afterthought” for investors.

Here are a few visuals that should help you visualize the “performance” problem…

Macro

Macro

(BofAML, Goldman)

So far this year, macro funds are flat. Or at least flat-ish. Returning just 0.38%. Not exactly SPY-like gains.

Well, one problem – not surprisingly given the global environment – is that carry trades aren’t pulling their weight (literally). Or, as Bloomberg’s Cameron Crise amusingly puts it, “macro traders are struggling because their favored strategies just aren’t working any more.”

Right.

Read more below…

Via Bloomberg

Equity hedge funds aren’t the only ones struggling with performance these days. Macro funds have also failed to move the needle much, by and large — the Bloomberg Macro Hedge Fund Index is largely unchanged over the past six years. Much like their equity counterparts, macro traders are struggling because some of their favored strategies just aren’t working any more.

  • Macro funds tend to bet on thematic global economic and policy shifts. While there has been plenty of volatility in the global economy over the past few years, tradeable changes in G-10 monetary policy have been lamentably few and far between.
  • Portfolio construction is also important in running a macro book. Often, the ideal macro portfolio has a few carry trades in it that pay for option-like payouts elsewhere. The carry makes a bit of money in quiet markets and the asymmmetric payoffs generate large returns during times of volatility.
  • Unfortunately, carry trades just aren’t what they used to be, thanks to low interest rates across the globe. A popular strategy is to go long the 3 highest-yielding currencies in G-10 and short the three lowest-yielding currencies. That strategy generated fantastic returns for a dozen years leading up to the crisis, but hasn’t worked since.
  • Even if we include higher-yielding EM currencies, FX carry returns have been decidedly mediocre. A strategy that blends G-10 and EM FX carry returns has not made money since 2008.
  • The correlation with macro hedge funds returns is notable.
  • FX carry strategies may also explain the strength of the yen. The Japanese currency was a short in the G10 FX carry basket for the entirety of 1995-2014, but dropped out when Swedish rates went negative in 2015.
  • Perhaps it’s a coincidence that USD/JPY peaked as the SEK has remained “strangely” weak since then, but somehow I doubt it.
  • This isn’t to say that global macro cannot perform without a tailwind from FX carry, but it sure would be easier if it had one.
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