Last time we looked at global macro hedge funds, what they are and why they are so enormously powerful.
What does it take to get a hedge fund job as a global macro hedge fund manager? Since the world it their oyster, a macro fund manager needs to know a lot about many different regions of the globe. They are often focused on practical economics, factors that drive inflation, exchange rates, trade deficits and more. Global macro managers tend to have a highly quantitative approach to the market and raw data. They may travel more than the average hedge fund manager, but not always. They must still enjoy sitting at a trading desk and making big bets on world markets.
By looking at opportunities around the world, macro managers can often produce returns over domestic stock indexes, and with a very different risk profile as well. A macro manager invests around the world wherever he feels the markets, currencies or commodities are likely to do well. And he shorts those regions that have a less optimistic outlook.
Of course the world is a big place, so some macro managers specialize either in their domestic market (U.S.), the most developed countries in the international market (tracked by Morgan Stanley’s EAFE index, for example), or specific regions of the world such as the BRIC developing nations (Brazil, Russia, India, China). Some focus on the Eurozone made up of EU countries.
There are many different approaches to capitalizing on macro trends. But all macro hedge fund managers have a few things in common. First, they are willing to invest across multiple sectors, using multiple financial instruments. They move easily from trend to trend or strategy to strategy, depending on wherever they spot opportunities that result from economic policies, interest rate moves or political changes.
Some macro managers use leverage, which can generate huge returns but with very high volatility. While others prefer to aim for consistent returns, without leverage, and may use derivatives for hedging their risks.
How do global macro managers identify trends that are worthy of placing multi-billion dollar bets? That’s a subject for numerous books, including George Soros’ fascinating tome, The Alchemy of Finance. In it, he discusses the government fiscal and monetary policies that history has shown to move markets.
References:
Jaeger, Robert A., All About Hedge Funds: The Easy Way to Get Started. McGraw-Hill.
Logue, Ann C., Hedge Funds for Dummies. Wiley Publishing Inc.
Friedland, Dion. Global Macro Investing. Magnum Funds. www.magnum.com
The term global macro is used to describe a group of hedge funds that take positions in markets around the world based on big, “macroeconomic” factors such as interest rate movements, currency markets, global stock and bond trends, commodity prices, political changes, government policies, and other very broad systemic factors.
Global macros have been described as the “grizzly bears” of hedge funds: big, powerful and aggressive. They aim to profit from changes in the global economy, sometimes using leverage to accentuate their predictions of market moves. They can be extremely profitable, but are also quite volatile, and can produce massive losses as well as gains.
Many of the biggest and most famous hedge funds are macro funds. They need to be big because they need a great deal of capital to take positions around the world. Because of their size, macro funds tend to get much of their investment capital from large institutions and the world’s wealthiest investors.
Perhaps the most famous global macro fund is the one run by George Soros. Soros is the founder of Soros Fund Management. In 1970 he co-founded the Quantum Fund with Jim Rogers, which created the bulk of the Soros fortune. On Black Wednesday (September 16, 1992), Soros became famous when he sold short more than $10 billion worth of pounds, profiting from the Bank of England’s reluctance to either raise its interest rates to levels comparable to other EU countries or to float its currency.
Finally, the Bank of England was forced to withdraw the currency from the European Exchange Rate Mechanism and to devalue the pound sterling. Soros earned an estimated US$ 1.1 billion in the process. He was dubbed “the man who broke the Bank of England.”
He did it again in 1997. Soros and other hedge fund managers believed that the currencies of Thailand, Indonesia, Malaysia and the Philippines were overvalued relative to the US dollar and other world currencies. Therefore they shorted huge amounts of the currency (borrowing the currency and selling it, hoping to repay the loan when the borrow currency depreciated).
When it became clear that the currencies were in fact overvalued and that everyone was short, the currencies went into a freefall, (which may have helped precipitate the so-called Asian financial crisis of 1998 . The hedge funds posted huge profits. Former Malaysian Prime Minister Mahathir Mohamad accused George Soros of ruining Malaysia’s economy with “massive currency speculation.”
Thus, global macro hedge funds are the often the ones that political leaders hate, that top traders want to work for, and that make international headlines. They can have an enormous impact on exchange rates, particularly in developing countries.
Next time, we’ll look at what it takes to be a global macro fund manager.
Last time we looked at the overall category of event-driven hedge fund strategies, which includes risk arbitrage and distressed debt investing.
The second category, distressed debt investing, seeks to take advantage of special opportunities that arise when companies in financial trouble undergo restructuring.
In these situations, the various classes of lenders in an organization (senior bondholders, etc.) fight over who gets what, while the equity shareholders are usually left with nothing.
The distressed debt specialist tries to buy debt at a deep discount, betting that it will be worth more when the restructuring process is completed. For example, he may buy the bonds of a distressed company at 25 cents on the dollar, hoping to double his investment or even get full face value of $1 if the company is restructured effectively.
This bond investing strategy is quite different from other bond strategies. Instead of seeking steady income over time as many bondholders do, the distressed debt investor is looking for a short, quick gain in a bond’s price.
Distressed debt investors usually buy two kinds of bonds: 1) “stressed” bonds that still pay interest, but the company issuing them is having trouble paying its debts; and 2) defaulted bonds which are no longer paying interest but which may rise in price and thus provide a capital gain. Both types of bonds trade at a deep discount to their original face value. And as a company’s financial problems get worse, the price of its bonds may fall even lower. If a company goes bankrupt, the bonds are considered “defaulted” bonds.
It’s important to remember that even if a company goes into bankruptcy, the bonds may still have value. Chapter 11 of the U.S. bankruptcy code allows companies to reorganize their finances while under protection from creditors. The goal is to avoid Chapter 7, an overall liquidation of the company.
Even in bankruptcy, there is a definite “pecking order” as to who gets their share of the remaining assets, starting with senior, secured credit holders on down to equity shareholders. But professional distressed debt investors who buy defaulted bonds expect to see the value of their bonds increase during the reorganization process.
Distressed debt investors have sometimes been referred to as “vulture” investors, picking over the carcass of a dead company. But they are not responsible for the financial mess the company is in. And in fact, distressed debt investors play an essential role in the reorganization process by providing liquidity to more traditional bond investors.
References:
Jaeger, Ph.D., Robert A. All About Hedge Funds, The Easy Way to Get Started. McGraw Hill, 2003.
