Are Macro Gods in Big Trouble?
Financial markets no longer make sense to macro managers like Mark Spindel.
After spending three decades focusing on things like economic trends, currency moves, politics and policy, Spindel has been confounded by markets shaped by low volatility, algorithms and more. He finally gave up and closed his nine-year-old hedge fund.
“I felt the intensity of following markets at a time of increasing political and economic confusion very hard,” said Spindel, founder of Potomac River Capital in Washington. “My entire career had centered on an understanding of monetary politics and I had trouble getting my head around it all. It was exhausting.”
These are troubled -- and troubling -- times for macro managers, those figurative heirs of famed investor George Soros who were once dubbed the masters of the universe. They’ve barely made money this year and once again, their returns pale next to those of cheaper index funds. Many investors are looking elsewhere.
Andrew Law at Caxton Associates has posted record losses. Alan Howard had the worst first-half in his hedge fund’s history. Even the old hands in the business such as Louis Bacon haven’t been spared from losing money. And Soros’s son, Robert, conceded last month that his family firm has made fewer macro bets amid “lackluster” opportunities.
It’s enough to make a macro man wonder: in an age of untested central bank measures and algorithms, can this classic hedge fund style pay off like it used to?
Opaque Markets
The old guard made their fortunes when markets were more opaque, less efficient and when they had access to market information privy only to a few. Price trends were easier to latch onto, leverage heavily used and competitors fewer. Today, funds face an onslaught of technology that’s disseminating information more quickly and widely, while some algorithms are able to spot -- and capture -- price anomalies almost instantly. And computer models can more cheaply follow market trends.
Macro managers posted their worst first-half since 2013, losing on average of 0.8 percent after a 1 percent decline in June, according to Hedge Fund Research Inc. data. The managers returned less than 1 percent annually over the past five years. The broader hedge fund industry returned 3.7 percent in the first half after barely making any money last month, and returned about 4.9 percent annualized over the past five years, the research firm said.
After winning a brief reprieve at the end of 2016 in the wake of President Donald Trump’s election win, macro managers’ fortunes reversed this year as the dollar and oil declined, stocks rallied and a political crisis erupted in Brazil. Volatility in equity and currency markets also fell to their lowest in years. In recent weeks, though, the dollar and Treasury yields have risen amid a hawkish tone from developed-nation central banks.
Investors have lost patience with the strategy. They pulled about $3.8 billion from discretionary macro managers in the first quarter, the fifth straight quarterly outflow, while adding $4.9 billion into computer-driven macro funds, HFR data show.
For years, managers have blamed central bank policies for their failure to deliver stand-out profits. Low interest rates globally made it harder to make money from differences among nations, they say. And as computers probabilistically forecast economic and market data, some managers say it’s a challenge to compete with algorithms that can be a driver of short-term price action, and create shorter and sharper investment cycles.
Disconnected Markets
Spindel, a former investment chief at a World Bank unit, is searching for answers to why macro didn’t work for him. Things started going awry for the 51-year-old just after Greece skirted Grexit two years ago. Spindel was wrong footed by China’s currency devaluations and Brexit -- at times trading from his couch at home during the night to keep abreast of political developments overseas.
Over a salad lunch during a visit to New York last month, Spindel recounted times when he got his economic forecasts right but market predictions wrong. He referred to charts that show a declining relationship between economic-data surprises and bond yields, and discussed how he was perplexed by new central bank measures.
“The dispassion felt harder in the Grexit-Brexit window,” Spindel said, whose fund generated an annualized 11 percent return from 2007 to July 2015. “Markets had become increasingly disconnected with economics and politics.”
In addition, increased regulation and fee pressure made it more expensive to run his $760 million firm, he said. After losing 12 percent through September last year, he returned money to clients.
Elephant in Room
“The elephant in the room is that macro should have done well in the past seven or so years because of all the political and economic events,” said Adam Duncan, a managing director at Cambridge Associates, a Boston-based firm that advises clients on investing. “Yet no one has made any money. The idea that the opportunity set hasn’t been there is just not true. Markets have been moving all over the place.”
For example, in the past two years the pound touched its lowest against the dollar in more than three decades, the Canadian dollar fell to its lowest since 2003 and gold dropped to a five-year low.
Managers need to increase risk and some should do more tactical trading, which is moving in and out of positions more frequently, Duncan said.
Some founders have had to rethink their business models, especially those who employ scores of managers that have been hamstrung by risk limits. They’ve cut their fees while some have stepped to the fore.
Brevan, Tudor
Howard, whose clients are fleeing his Brevan Howard Asset Management, delegated management of his firm in September to deputies so he can focus on markets, according to people who know him. And earlier this year, the no-nonsense, straight-talking billionaire turned to coach and U.S. chess champion Josh Waitzkin to help hone his trading skills, the people said. Waitzkin, who was the subject of the 1993 film “Searching for Bobby Fisher,” runs programs that involve practicing mindfulness and journaling, according to his website.
Brevan has lost 5.2 percent this year. A spokesman for the firm declined to comment.
Paul Tudor Jones, whose Tudor Investment Corp. has also seen clients defect, last year told investors that he will handle a greater chunk of their money and push his managers to take on more risk. His fund is down 2.5 percent this year through June. And Caxton, where Law already manages most of the firm’s money, told investors that it was shifting away from a strategy called momentum. The firm has slumped 10.4 percent through June.
While managers like Leland Lim in Hong Kong closed their macro funds this year, others including Law and Jones have anticipated the day when markets will make sense once again and they’ll make a comeback. Bacon, who runs Moore Capital Management, last year said he’s “exceedingly upbeat” for the first time in years about the “game-changing” trading opportunities following Trump’s election win. His fund fell 2 percent this year through June 22.
Representatives for the firms declined to comment while a spokeswoman at Caxton didn’t return messages seeking comment.
Despite the current malaise, there are some bright spots. A younger cohort of managers such as Jeff Talpins and Chris Rokos, who heavily rely on options for their trading, have garnered billions in new investments this year even as they haven’t made money, while macro funds that focus on emerging markets such as Glen Point Capital are outperforming.
Back in Washington, Spindel is upbeat. He’s managing his own money while putting the finishing touches to a book he’s co-written about the Federal Reserve that’s due to be published later this year. Spindel regularly rows on Washington’s Potomac River in a single scull rather than his former eight-man boat. One day he may return to managing other people’s money, he said.
“I would love to be back in an eight again.”
Below is a sampling of performance by macro funds, compiled by Bloomberg (click on image):
Source: Investors, Bloomberg News
It's been a brutal year for large macro funds, especially Brevan Howard. According to an investor letter seen by Bloomberg News, its main hedge fund suffered its fourth straight monthly loss in June, slumping 1.5 percent, and its assets are shrinking fast:*through June 30**through June 22***through May 31^Since fund’s start in March
Headcount at Brevan Howard has been heading down this year, as Alan Howard’s hedge fund deals with fund outflows and ongoing poor performance. Still, Howard bit the bullet recently and hired a top quant, Duncan Larraz, who was latterly head of quant analytics at asset management firm Tages Capital. He joined Brevan Howard as a strategist in June.
Howard, 53, is fighting to reverse client withdrawals. The Brevan Howard Master Fund managed $8.2 billion at the end of May, down from almost $28 billion in 2013, investor letters show. The main hedge fund returned 3 percent in 2016, its first annual gain in three years, according to an investor letter. The fund lost 0.8 percent in 2014 and almost 2 percent in 2015.
Macro funds rose just 1.2 percent on an asset-weighted basis in the first five months of the year, the least among the main strategies tracked by Hedge Fund Research Inc. Equity and "creative financing" strategies, such as direct lending, are among the most attractive this year, said Darren Wolf, head of hedge funds for the Americas at Aberdeen Asset Management. The money manager is still positive on macro hedge funds because it expects "more volatility around the corner," Wolf said.
Moreover, Howard has been busy seeding managers like Giles Coppel, a top trader in Brevan Howard's New York office, who will receive $200 million from the firm to start his own macro fund:
Coppel has headed trading at Brevan's New York office since 2012, according to his Bloomberg profile. He previously worked at Tudor Investment Corp. and Lehman Brothers, according to the profile.It should also be noted that in ealy 2015, Brevan Howard made peace with its former star trader Chris Rokos, and agreed to help him set up his own business, ending a legal battle that had threatened to spill over into a high-profile court case.
Coppel couldn't immediately be reached for comment. The people familiar with the launch asked not to be named because the information is private.
Brevan was once one of world's largest hedge fund firms. It has been struggling over the past few years, with assets tumbling to about $12.6 billion at the end of May, a person familiar with the situation said. That's a big drop from its peak of around $40 billion in 2013.
Coppel's launch would follow others from Brevan alumni.
Earlier this year, former Brevan partner Ben Melkman launched Light Sky Macro, one of the largest launches of the year.
You'll recall I discussed Chris Rokos in my comment on hedge fund quants taking over the world and in a comment last year, One Up on Soros, where I discussed him and Scott Bessent, Soros's protege who went on to start his own macro fund, Key Square Group, with $2 billion seed capital from Soros.
I haven't heard much aabout Key Square but read that Bessent bought a co-op at the storied 720 Park Avenue for $19.3 million and gave $1 million to Trump's inauguration committee (Soros was probably not too happy about that). So I guess he's doing alright but who knows, it's a brutal environment for macro funds so far this year.
Rokos Capital Management is down 4.1% through the end of May (was down 5+% at the end of Q1) but I think very highly of Chris Rokos and wouldn't worry too much about the bad start to the year. If anyone can make back losses quickly, it's this guy, he has a license to print money when many others typically struggle.
Still, I talk to my buddy in Toronto, the one-man currency hedge fund machine, and he tells me he's beating his peer group but it's a brutal market for currency hedge funds (unless they're selling vol) and most of them cannot make money because currency markets are trendless, or the ranges are too tight, or they move in opposite direction of the fundamentals. He added: "It must be hell working at these big hedge funds, the bigger you are the harder it is to make money".
My buddy is right, for big macro funds, size is not your friend in this market, which is why you see guys like George Soros and Alan Howard seeding their top talent. They know it's better to seed talent and let them try to earn money on their own, hopefully reaping big gains by owning a piece of the management company.
But it's not just macro funds that aren't doing well this year. Last week, Dani Burger of Bloomberg reported, Cross-Asset Quants Are Facing Their Worst Losses in a Decade:
Hawkish signals from central bankers have punished stocks and bonds alike in the past week.I used to allocate to large global macro funds and large CTA funds all over the world. Macro funds use fundamental analysis to enter into their trades while CTAs use quant strategies based on prices. Macros tend to be early to a developing trend and tend to leave earlier too whereas CTAs come in later but ride the trend longer.
Also punished: investors who make a living operating in several asset classes at once. They’ve been stung by the concerted selloff that lifted 10-year Treasury yields by 25 basis points and sent tech stocks to the biggest losses in 16 months. Among the hardest-hit were systematic funds who -- either to diversify or maximize gains -- dip their toes in a hodgepodge of different markets all at the same time.
Losses stand out in two of the best-known quant strategies, trend-following traders known as commodity trading advisers, and risk parity funds. CTAs dropped 5.1 percent over the past two weeks, their worst stretch since 2007, according to a Societe General SA database of the 20 largest managers. The Salient Risk Parity Index dropped 1.8 percent, the most in four months.
To a category of critics, it’s an environment where the potential for snowballing losses becomes greater, as the overseers of such funds take steps to reduce risk. So many face losses at once, the theory goes, that a chain reaction of selling ensues with the potential to whack markets further (clickon image).
So far, there’s no clear indication that’s happening. Selling in U.S. equities has been confined mostly to tech shares, with financial stocks rising toward 10-year highs. Bonds yields have spiked, but remain below levels seen in May.
Any systematic selling was probably drowned out by discretionary managers, according to Roberto Croce, director of quantitative research at Salient Partners LP.
“I don’t think we can say that the moves in the market are due to them,” Croce said. “Some portion of the investing base freaks out and runs for the hills, but these types of portfolios tend to snap back quickly if you don’t take any risk off. It’s much more likely to be discretionary investors that are fleeing whatever they’re holding without a plan.”
SSS
It’s far from clear risk-parity and CTA funds react to the same set of inputs. While both invest in multiple asset classes and employ leverage, risk parity tends to be a slower and more passive strategy, aiming to engineer a smoother ride by giving smaller weightings to higher-volatility assets. CTAs, a type of managed futures strategy, follows short-term trends and tends to be more volatile and less correlated to the market.
Risk parity would only unload positions quickly if managers kicked in some type of stop loss, which only a few do, according to Croce.
That may be true for the biggest players, but doesn’t account for the actions of a less illustrious category of risk parity funds, many of which have started to unwind, according Brean Capital LLC’s Peter Tchir.
“I don’t think this move has caused much of an unwind from true risk parity funds, but much more from the homebrew or risk parity lite crowd -- making the real fun just beginning,” Tchir wrote in a note Thursday. “Risk parity selling should kick in when expected volatility of the strategy exceeds target volatility of the strategy.”
As employed like Bridgewater Associates LP’s All Weather Fund, risk parity holds consistent levels of exposures. When it rebalances, the fund buys assets that have fallen and sells ones which have gained -- hardly a recipe for disaster. AQR Capital Management LLC does use a risk management strategy to gradually reduce exposure when returns are very poor, but that hasn’t kicked in all year, according John Huss, a portfolio manager on the risk parity team.
“We’re not trying to chase one day or one week moves,” Huss said. “When there are larger shifts in exposure, like the way we were positioned in 2008 versus 2012 with really noticeable changes in size, they tend to happen more slowly over time.”
CTAs may be a bigger threat. They’re large -- Barclays PLC estimates them to be about 7 percent of hedge fund industry assets -- and react quickly. Take $1.4 billion Quest Partners LLC, which runs mostly managed futures funds. Before last week the firm was mostly long Treasuries, and has already flipped to a short position, according to Nigol Koulajian, co-founder and chief investment officer (click on image).
Last week’s pain wasn’t as clear cut as a selloff in fixed income for some trend-followers. The managed futures fund at Salient, for example, suffered from a short position in agricultural commodities after wheat futures rallied to four-year highs.
“Momentum trading can create systemic risks. CTAs are a good example, they’ll ride the trend up and ride the trend down,” said Maneesh Shanbhag, who co-founded $500 million Greenline Partners LLC after five years at Bridgewater. “Connecting that to risk parity, the more basic idea will not cause instability in markets. But a levered risk parity strategy is at risk of all asset classes falling.”
On the surface, it’s strange that both strategies suffered over the past week since they’re supposed to behave differently. A classic risk parity strategy is always long fixed income, equities and inflation risk assets. But as momentum threw its weight behind stocks and bonds, many CTAs took a similar long position.
It gets worse zeroing in on CTAs: about half of the assets are controlled by 10 managers, who are about 98 percent correlated, meaning same-way bets will indeed affect the market, according to Quest’s Koulajian.
“CTAs who have adapted to this market environment are trading more and more long-term, and their position sizing has grown,” Koulajian said. “Many people are using exactly the same strategy, and as there’s a reversal in trends, they’re impacting the market significantly.”
Together, macro and CTA funds account for a huge portion of hedge fund assets, with L/S Equity being the most popular strategy.
As far as risk parity strategies, I think there is a bunch of nonsense being disseminated out there, including from well-known macro manager Paul Tudor Jones who back in April warned us to be very afraid of these markets, blaming risk parity strategies for the coming downfall of markets.
I'm more worried about the ongoing ETF bubble which keeps expanding to the point where even John Bogle recently came out to warn index investors.
Fret not my dear macro gods, there is good news ahead. As I explained on Friday when I dismissed Ray Dalio's notion that we are witnessing the end of central banks' era, the Fed is making a mistake, raising rates at a time when the US economy is clearly slowing.
I believe the Fed wants to raise rates to have ammunition to cut rates when the next crisis hits us in the not too distant future but as central banks turn hawkish, I worry that they will only exacerbate global deflation.
Smart global macros know exactly what I'm talking about and let me repeat my macro positions:
[..] here are my global currency positions:One final note to my institutional readers, take the time to carefully go over a document Francois Trahan and Michael Kantrowitz of Cornerstone Macro put out this week, A Review Of H1 2017 ... And What Lies Ahead (July 10, 2017). If you are not a subscriber to Cornerstone's research, make sure you become one, it's well worth it.
I see global economic weakness ahead which is why I'm short oil and other commodities. People are delusional, the US economy isn't as strong as they think. Jim Chanos gets it but to my surprise, so many others are completely out to lunch.
- Long the US dollar. Buy this weakness. The weakness in the US dollar is only temporary. As the US economy slows and everyone is talking about how great Europe is doing, pounce on the opportunity to load up on the greenback. Europe and Japan will also enter a significant slowdown over the near term and their currencies will bear the brunt of this slowdown.
- Short the CAD, Aussie, Kiwi and commodity-related currencies, including many emerging market currencies.
Even Jeffrey Gundlach is disappointing me, stating the bond wipeout is just beginning. Really Mr. Gundlach? My advice to institutional investors is the same as at the start of the year when some were warning it's the beginning of the end for bonds, namely, keep loading up on US long bonds (TLT) on any weakness. When the next crisis hits in the near future, you will thank me for saving your portfolio from being obliterated.
In short, I remain long US long bonds (TLT), the US dollar (UUP) and select US equity sectors like biotech (XBI) and technology (XLK) and I'm underweight/ short energy (XLE), metal & mining(XME), industrials (XLI), financials (XLF) and emerging markets (EEM).
In short, the second half of the year will be a lot more difficult than the first half, so get ready for some rock n' roll and be prepared for negative economic surprises. This should help many macro funds that are struggling this year.
Below, Peggy Collins of Bloomberg News discusses why macro managers are having a rough year. Computers, low volatility in currencies, and central banks are the reasons often used as why macro managers are failing to deliver, but I can't stand flimsy excuses for underperformance, especially from managers that have more money than they know what to with. If you can't deliver, do what Mark Spindel did, return the money to your clients who will find somewhere else to place it.
I also embedded another clip where Mark Yusko, CEO and CIO of Morgan Creek Capital Management, makes a prediction that a bubble in US equities will burst and crash the stock market later this year. I worry that he might be right but his timing might be off (it could happen next year).
Update (01/08/17): Bloomberg reports investors are increasingly deserting Paul Tudor Jones. The billionaire macro manager who helped give rise to the hedge fund industry saw clients pull about 15 percent of their assets from his main fund in the second quarter, according to investors who asked not to be identified discussing private information. That’s left client assets at about $3.6 billion, almost half the value a year ago.
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