Despite being the laggards of the hedge fund industry over the past five years, macro funds are looking to return to form in 2013 as a dramatically shifting global environment plays to their advantage. However, some trends observed by industry experts may weigh on the ability of managers using these strategies to outperform the broader hedge fund industry. A change in investor types has shifted the focus from large scale profit and loss swings to managing towards lower volatility. This reduced risk appetite may keep many funds on below average hedge fund performance, despite a favorable macro environment for the strategy.
Over the last five years macro focused hedge funds, which use elaborate models to allocate capital between various regions based on economic outlook, have only earned approximately 2.2 percent per year. This compares poorly to the 2.8 percent for the broader hedge fund index, even though that level of return is somewhat disappoint in of itself. This year hedge funds have shown some signs of improvement with an average return of 4.4 percent after fees to the end of April, but macro funds continue to trail posting only a 2.3 percent gain.
New School, Old School Approaches to Risk Taking
In their analysis of the performance of macro funds, the Financial Times cited the commentary of Mark Dow, who writes the Behavioral Macro Blog. Dow believes that macro fund managers can be broadly split into two groups, with an old school or new school approach. Old school managers, reminiscent of George Soros, took big fundamentally driven bets with substantial risk, as they were willing to take large swings in their period return in order to outperform over time. The new school managers take a much more conservative approach, using macro models primarily for risk management purposes.
One of the big drivers behind this switch is the clientele of hedge funds today. Prior to the financial crisis, hedge funds were the domain of risk takers or otherwise sophisticated investors that could tolerate some volatility if it suited their portfolio objectives. Now, however, this clientele base has shifted with hedge funds marketing aggressively to pension funds and other institutional investors. In order to attract many these clients, lower volatility in earnings is required when compared to the old school, more cowboy approach to macro fund management.
Low Volatility Approach Likely to Remain as Long as Institutional Money stays Interested
This focus on lower volatility is likely to continue so long as hedge funds are viewed as a viable mainstream investment class for institutional money managers. With fixed income yields hovering near historical lows, these fund managers will continue to look to hedge funds as a source of diversification that may offer more return upside than languishing Treasuries. And of course, hedge funds will be eager to capture this potentially large source of fee revenue by making adjustments to their investment strategies.
That said, a real opportunity does exist for macro fund managers in light of the untested monetary policy being undertaken in many countries today. Rapid currency movements and highly volatility equity and debt markets will remain the name of the game for some time. If some fund managers adopt a more old school approach, they could certainly stand out as all-stars in a segment of the hedge fund world that has been struggling to post exceptional returns.