Are Macro Funds Bringing Home the Bacon?
Louis Bacon's decision to return $2 billion to investors highlights the difficulties the biggest macro hedge funds are having this year as government intervention and declining trading volumes limit managers’ ability to make large bets.
Bacon told clients in a letter yesterday he’s giving back about 25 percent of the money in his main hedge fund after returning just 1.6 percent this year through July. Ray Dalio, who runs Bridgewater Associates LP, lost 2 percent in his $54 billion macro fund through July 20, according to investors. Alan Howard, who runs Brevan Howard Asset Management LLP, lost 1.3 percent in his Master Fund in the same period.
Investors had high hopes for macro funds because they managed to weather the 2008 financial crisis while other strategies tumbled. They poured $4.2 billion into the funds in the first half of this year, according to Chicago-based Hedge Fund Research Inc., or about a fifth of all deposits into the industry, figuring there was money to be made in markets dominated by macroeconomic themes. That’s proven too much as new regulations prohibiting banks from trading for their own account reduced liquidity and government action made timing trades harder.
“Ongoing systemic shocks are resulting in market behavior that is consistently inconsistent,” said Brad Balter, head of Boston-based Balter Capital Management LLC, which invests client money in hedge funds. “That causes traders to put on smaller positions, making it harder for the largest managers to profit.”
Macro funds trade in global equity, bond, currency and commodities markets. They lost an average of 1.3 percent in the first six months of the year, according to data compiled by Bloomberg. That compared with a gain of 6 percent by the MSCI ACWI Index and 2.8 percent for the Bank of America Merrill Lynch Global Broad Market Index.
Until this year, the bigger funds were able to produce top returns. Bridgewater, based in Westport, Connecticut, climbed 25 percent last year, and in 2010 it jumped 45 percent.
Brevan Howard, which manages $26 billion in its Master Fund, returned about 12 percent last year. This year, the losses have been primarily in global interest rate bets, according to a monthly shareholder report for its publicly traded entity.
Caxton Associates LP, run by Andrew Law, lost 2.8 percent through July 17, investors said. Paul Jones’s Tudor BVI Fund climbed 3.3 percent through July 20 and Greg Coffey, who manages an emerging-market macro fund at Bacon’s Moore Capital Capital Management LLC, lost 5 percent this year through July 31, clients said. The investors asked not to be named because the funds are private.
Officials at the funds declined to comment.
Bacon, 56, said he is returning money because there are fewer opportunities and less liquidity in global markets. His main fund oversees $8 billion and the firm manages $15 billion.
In currency markets, Bacon wrote, government intervention has caused the percentage difference between the strongest and weakest of the Group of 10 currencies to be the narrowest since the fall of Bretton Woods, the system of fixed currencies that ended in the early 1970s.
Banks have cut back their proprietary-trading desks over the past year in preparation for the Dodd-Frank provision that limits banks’ ability to make bets with their own money. That is making it more difficult to trade large positions, Bacon said.
Trading volume in shares globally fell 18 percent in the first half of 2012 compared with the same period in 2011, according to the World Federation of Exchanges.
“The bulk of rallies occur at turning points on low trading volume. Subsequent momentum and trends are much less rewarding,” Bacon wrote. Markets are moving in tandem and “idiosyncratic opportunities, particularly in liquid markets where volume can be exploited, are becoming oases in an investment desert.”
One trade that went awry for many managers at the end of June was a bet against the euro. The trade was making money until June 29, when the euro surged as much as 2 percent against the dollar in one day, the biggest gain of the year.
The jump took place after European Union leaders, meeting in Brussels, said they would drop the condition that emergency loans to Spanish banks give creditor governments preferred status. At the time, investors said the euro gained because the agreement exceeded the market’s very low expectations going into the summit.
“Markets have become accustomed to euro-zone summits where the de facto best outcome is action that cuts off imminent tail risk, providing a brief short-covering rally that belies a concrete and important resolution,” Bacon wrote in the letter. “This action is then sufficient for the market to temporarily put the dysfunctional euro zone to one side to focus on more positive developments elsewhere.”
The unexpected moves have been harder for larger managers to navigate because they can’t put on or unwind positions as quickly as smaller players.
“The market environment has changed and it’s been even more volatile than we expected,” said Franck Dargent, deputy chief executive officer of Paris-based Amundi Alternative Investments, which invests about $12 billion in hedge funds. “To capture the short-term cycles, you have to be able to rotate the portfolio quickly.”
Some smaller macro funds have been able to perform well this year. Fortress (FIG) Macro Fund, run by Michael Novogratz and Adam Levinson, climbed 6 percent through the end of July, according to investors, who asked not to be named because the fund is private.
Gordon Runte, a Fortress spokesman, declined to comment.
The managers of the $3 billion fund made money being short the euro because they tend to sell their positions once they’ve made 1 or 2 percent, the investors said, avoiding the market gyrations that have hurt other managers. The fund also made money trading the Japanese yen, when it weakened at the beginning of the year and when it strengthened more recently, and on a bet that Brazil would lower short-term interest rates.
Fortress uses stops and hedges to ensure that it will not lose more than 3 percent of net asset value for its larger trades, and not more than 75 basis points on its shorter-term tactical trades. A basis point is 0.01 percentage point.
While investors pulled about $3.5 billion from macro funds in the second quarter, some say they are staying with the strategy, convinced that they are in the best position to exploit global imbalances in the longer term.
“Fundamental conditions are not driving the markets right now, so in the short-term it’s challenging,” said John Bailey, chief executive officer at Spruce Private Investors in Stamford, Connecticut, which advises clients on hedge fund and other alternative investments.
That means that macro funds have to have lower conviction about their trades and reduce the size of their positions, he said. Giving back money, like Bacon did, may be one way to lift returns in this environment.
“I can count on one hand the managers who have given money back,” said Brad Alford, head of Atlanta-based Alpha Capital Management LLC, who is an investor with Moore. “He’s giving up at least $60 million in fees annually to try to do right by his investors.”
Large macro hedge funds are struggling. In February, I wrote a comment on Louis Bacon's troubles. He is not alone and I think it's important for investors to realize that there are important structural factors that explain why the outsized macro returns of the past -- à la Soros -- are dead.
First and foremost, massive government intervention in developed economies have sunk global interest rates to zero and differentials of major currencies are at historic lows (read my 2010 comment on whether the world is heading to parity). Second, liquidity is drying up as banks exit proprietary trading, exacerbating volatility.
In this environment, large macro funds have to leverage up their positions to make decent returns but that can also kill them as volatility remains high.
Having invested in some of the best macro hedge funds, I can share some other insights with you. Most of these large funds focus on interest rates and currencies. A few of them are also trading equities and commodities but that's not their bread and butter. Big moves this year in commodities, especially in corn as hedge funds bet prices will continue to soar.
My feeling is that investors getting burned by hedge funds will be disappointed with returns from large macro funds. In this environment, the best funds will be those that are small and nimble. This goes for all hedge funds, not just large macro funds. In this regard, Louis Bacon is doing the right thing returning money to investors, becoming smaller to earn bigger profits.
Another right thing Louis Bacon is doing is nature conservation. He recently announced his intentions to donate 90,000 acres of land in Colorado toward the creation of the Sangre de Cristo Conservation Area (watch below). Good for him, that is a breathtakingly beautiful piece of land.
Also, Yahoo's Aaron Task interviews Dean Baker, co-director of the Center for Economic and Policy Research, discussing why the Fed didn't do more to spur economic growth. Maybe the Fed is more optimistic on economic growth than most doomsayers. Friday's jobs report will provide us with more clues on the state of the US recovery.