Bloomberg’s Cameron Crise – or, as he’s known to Jeff Gundlach, “who?” – thinks maybe it’s time for macro hedge fund managers to stop worrying so much about risk.
After all, there’s an old sports cliche (that I’ve actually heard twice this week) about how if you play “not to lose”, you invariably will lose because, well, because you’re not playing “to win.”
In a piece dated Tuesday, Crise (who is a risk taker and a ‘swashbuckler’) is taking aim at the “deplorable” practice of focusing too much on risk-adjusted returns as opposed to just plain old returns.
To be sure, Crise has every reason to lampoon macro managers. After all, by many accounts macro funds performed the worst of any strategy in June, losing 1.6% and there’s been no shortage of commentary on their YTD trials and tribulations.
At the same time, I’m not 100% sure that a return to the “swashbuckling” days (as Crise puts it) is the answer.
Anyway, read below as Crise explains how if Warren Buffett were operating under the risk framework of a macro trader, he would have been stopped out in 18 of the 30 years…
In sports, it’s said that it’s hard to win when you play not to lose. Such is the lot of the modern global macro manager, where a cult of loss avoidance has contributed to a string of mediocre returns.
- While the phrase “global macro hedge fund” conjures images of swashbuckling traders delivering heaps of volatility, the reality is that those types of funds ceased to be relevant after the dot-com bubble. Their modern replacements focus on tight risk controls and portfolio construction to optimize risk- adjusted, rather than nominal, returns.
- In theory this is a sensible idea, particularly when there are a large number of independent opportunities. In recent years, however, it has encouraged traders to focus on maximizing the probability of a positive return rather than the expected return.
- Ironically, this has encouraged a negative feedback loop of concentrated positions held with low conviction, generating a wave of stop losses. To be sure, the macro policy environment has not helped.
- What if other investors had to operate within the risk framework of a macro trader? For example, what if Warren Buffett’s Berkshire Hathaway had a 12% annual stop loss, after which it would quit trading until the new calendar year?
- It turns out that Buffett would have been stopped out in 18 of the 30 years for which Bloomberg has data for the BRK share price. In fact, between 1997 and 2005, a risk-managed BRK would have delivered zero return versus the 8.5% annual gains that Buffett actually produced. Had he been trading macro, there’s little doubt he would have been fired.
- Still, you can see why macro funds operate with stops. Berkshire’s three largest annual losses would have been significantly mitigated with 12% stops. And while the annual return would have dropped from 15.1% to 12.7%, the annual volatility would have dropped more: from 22.9% to 14.5%.
- That 2.4% difference in annual returns may not seem like much, but over time it adds up. Since 1987, a Berkshire with a 12% stop loss would only be worth half of today’s behemoth.
- Perhaps it’s a coincidence that Michael Platt’s Bluecrest returned nearly 50% last year after ditching clients and ramping up risk — but somehow that seems unlikely.
- No one is saying that macro funds should abandon risk management altogether. But taking a more sensible approach and focusing on the upside as much as the downside could go a long way toward returning the industry to profit.