Investors looking for alternatives to highly priced bonds as a way of hedging falls in their equity portfolios have alighted on a novel option — macro hedge funds.
As bond prices have soared to record highs this year, helped by interest rate cuts and a flight to haven assets during the coronavirus pandemic, many investors have grown wary of the traditional 60/40 blend of stocks and bonds that has been the mainstay of investment portfolios for decades. Because bond prices are so high, they say, there is little room for them to rise further and compensate for losses from a stock sell-off.
Some are now looking to macro hedge funds as an alternative hedge. These funds, which bet on moves in global bonds, currencies and stocks — and which were made famous by billionaire trader George Soros — are enjoying a renaissance this year, helped by big swings not only in bonds but also gold and stocks.
“The traditional role of fixed income as a diversifier is certainly more challenged,” said Karen Ward, chief market strategist for Emea at JPMorgan Asset Management. Macro funds could be a good replacement, she added, given many of these strategies aim to make money during periods when investors sell risky assets.
“Macro funds have certainly performed well during periods of volatility,” she said, adding that question of whether products such as macro funds can replace bonds is “now at the forefront” of investors’ minds.
Macro funds “can be a good hedge for equity markets”, said Fiona Frick, chief executive of Swiss investment firm Unigestion, pointing to these funds’ flexibility and the range of assets they invest in. “We see demand for it,” she added.
Hedge funds have not always lived up to their name during equity market sell-offs. The sector lost 19 per cent, on average, in 2008’s market turmoil, according to data group HFR.
However, macro hedge funds — which make up about 18 per cent of total hedge fund assets, according to HFR — have delivered markedly different returns. Such funds tend to be far less exposed to overall stock market moves than the wider industry and made money in negative years for equities such as 2000, 2001, 2002 and 2008, according to analysis by JPMorgan. Alan Howard’s Brevan Howard, for instance, one of the best-known macro funds, made gains of more than 20 per cent in both 2007 and 2008 during the credit crisis.
During much of the bull market in equities over the past decade, macro funds delivered only lacklustre returns, persuading many investors to pull out their cash. But this year, funds such as Caxton Associates, Brevan and Rokos Capital are among those that have chalked up double-digit returns this year, said people familiar with their returns. Much of the gains have come during the choppy opening few months of this year when equities slumped on fears over the economic damage from the coronavirus pandemic.
Billionaire investor Stanley Druckenmiller recently predicted a resurgence in macro investing over the coming decade, as market volatility picks up again.
Bonds have a good long-term record in offsetting equity losses, and a 60/40 portfolio would have made money for investors for most of the past 40 years. However, the desire to find a replacement has grown this year as bonds have rallied, sending the US 10-year government bond yield down from about 1.9 per cent at the start of 2020 to just above 0.8 per cent.
Some investors fear that these high prices mean bonds could end up falling at the same time as stocks. Paul Singer’s US hedge fund Elliott Management said in a July letter to investors, seen by the Financial Times, that bonds no longer diversify portfolios or reduce risk, and that bonds and equities could fall at the same time. In September’s stock market wobble, bonds barely moved, offering investors little protection.
Macro funds do not provide a perfect hedge for stocks, losing money for instance in 2018 when most assets were in the red. Nathanael Benzaken, chief client officer at Lyxor Asset Management, said it was “inappropriate to suggest macro could replace fixed-income investments. You don’t have the same risk profile.”
One senior investment strategist at a major bank said macro funds do not necessarily need to move in the opposite direction to stocks to provide a substitute for bonds, but rather to provide returns uncorrelated to stocks.
Others think macro trading can provide useful protection, but are wary of the human element.
Aberdeen Standard Investments and BNP Paribas together recently launched a fund that tracks an index designed to hedge equity risk. The index uses some of the techniques favoured by macro hedge funds, such as buying equity options that effectively insure against market falls.
“The part we’ve been frustrated with in the past [is] where a discretionary manager hasn’t been positioned to benefit from the sell-off as they had their own view that they didn’t need as much protection,” said Russell Barlow, global head of alternative investment strategies at Aberdeen Standard.
“We’ve taken the uncertainty over the positioning of the hedge fund manager away,” he said.
Additional reporting by Ortenca Aliaj