Hedge Funds That Bet on Big Trends Are Trying to Bounce Back
(Bloomberg Businessweek) -- Greg Coffey’s hedge fund firm, Kirkoswald Asset Management, gained 28% for clients in 2019. That’s a decent profit by any standard, but what makes it more impressive is that Coffey is what’s known as a macro investor. That’s a tough trade to ply.
It wasn’t always this way. The macro style used to be synonymous with the hedge fund industry. Imagine a money manager sitting in judgment on the entire world, sifting through trends in global economies and geopolitics to make big bets on everything from currencies to interest rates to stock indexes. That’s macro. Its roots go all the way back to economist John Maynard Keynes, who had a side gig in the 1920s running money for the endowment of King’s College, Cambridge. Take any titanic economic event of the past century, and there was a macro manager making a reputation by profiting from it: The fall of the British pound had George Soros; the 1987 stock market crash had Paul Tudor Jones; and the financial crisis of 2007 and 2008 had Alan Howard.
But macros have struggled in the past decade or so. From 1990 to the end of 2008, returns for macro managers averaged 14% a year, according to Hedge Fund Research, or about twice the S&P 500’s gain. Since then the S&P has averaged 14.7%, while macro has eked out an annualized 1.9%.
Last year, Soros’s operation—now a family office that runs money for his philanthropies—fired most of its internal and external macro traders, all but dropping the kinds of trades that made him famous. Another hedge fund pioneer, Louis Bacon, effectively retired from the business in November, saying he was returning outside investors’ money in his three main funds and stepping back from trading. Bridgewater Associates’ Ray Dalio, who oversees about $80 billion in his Pure Alpha macro funds, lost money in his flagship fund for the first time in two decades. It’s averaged a return of about 4% a year since 2011.
One problem for macro is size. The funds were once relatively rare and relatively small, which helped in several ways. There was less competition when it came to seeking out key information—such as what central bankers were thinking—and a smaller asset base meant they could make meaningful trades without moving prices so much that their edge disappeared.
Then there are interest rates. The U.S. Federal Reserve pushed the key rate to almost zero after the financial crisis. Although rates have crept up since, they’re still low. Money managers can easily make money on falling rates—bond prices rise when rates fall—and they can use derivative contracts to profit from rising rates. But they’re stuck when rates barely budge. Jones, the hero of ’87, groused in 2014 that hedge funds needed “a macro doctor to prescribe central bank Viagra”—that is, higher rates.
Technology is shrinking the opportunities for macro managers, too. Information moves faster, making it harder to stay ahead. Algorithm-based quant traders smooth out disparities in market prices so quickly that potential profits get smaller, and it gets harder for managers to discern anything as squishily human as market sentiment.
It doesn’t help sophisticated macro managers’ case that investors are doing just fine with simple strategies. S&P 500 index funds rose 29% in 2019, far more than most macros. Being trounced by a diversified buy-and-hold investment available to most people with a 401(k) is awkward for Wall Street heavyweights who routinely charge even more than the traditional “2 and 20”—a 2% management fee, plus 20% of profits—that other hedge funds levy. In fairness, most hedge funds don’t simply promise high returns—they advertise consistency. Still, few clients are likely to be impressed by average returns below 2% in the midst of a long bull market.
Despite these challenges, some managers have been putting better numbers on the scoreboard. Beside Coffey, there’s Ben Melkman, whose Light Sky Macro fund climbed 18% in 2019. Jeff Talpins, who runs 15-year-old Element Capital Management, has been beating his peers for much of the past decade, and his fund rose 12% last year. Even Jones, who struggled for several years, produced an 11% return in 2019 after climbing 10% the prior year.
One thing that’s likely helped some macro funds is that interest rates are finally offering a little action. After modest Fed hikes beginning in 2015, the central bank turned around and cut again in 2019, creating an opening for a big trade on the direction of rates. It may also be that modern macro traders have stopped waiting for the end of the low-interest-rate era in Europe, Japan, and the U.S. They’ve taken the “go-anywhere” mandate of classic macro seriously and scoped out new places to invest.
Some, like Coffey, focus more on developing markets. While some of his gains came from trading rates in the U.S., he also caught government bond moves in Brazil, Chile, and Russia, according to a person familiar with the firm. Melkman profited by betting on Brazil’s currency, as well as shorting Norwegian bonds, according to investors. (Despite overall U.S. equity gains, he also made money shorting stocks in May when they briefly plunged.)
Others did well by learning to love the market rally. Talpins’s Element made much of its gains from bullish equity wagers. Another advantage has been a heavy investment in technology, with detailed models that, for example, weigh the impact of quantitative traders on the market.
Some managers fundamentally changed the way they invest. Andrew Law decided two years ago, amid losses at his Caxton Associates, that he would put more money on themes that would take two to three months to play out. This was an acknowledgment that quant trading had made shorter-term trades unprofitable, according to investors. Caxton made 19.5% in 2019. Michael Platt, a British macro manager who gained 50% last year, decided his best bet was to stop running outside money. He kicked clients out of his BlueCrest Capital Management a few years ago because, in part, investors wouldn’t stomach how much leverage he wanted to use.
With the divergence of returns among macro funds, it will be harder for macro managers to blame only difficult market conditions. “For the most part, there are always things to do in macro,” says John Sedlack III, an investment manager focused on macro hedge funds at Aberdeen Standard Investments. “For those who purport to not see macro opportunities, it’s likely they haven’t cast a wide enough screen.”
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