Is Global Macro Already Going Out of Style?
Two articles by the Wall Street Journal’s Tom Lauricella, one of my favorite writers, came across my desk last week. With titles like “’Go Anywhere’ Goes Awry” and “Macro Funds Show Micro Returns,” the message was clear: Go Anywhere mutual funds and global macro hedge funds are having a tough time earning positive returns in the current market environment.
We at Pinnacle describe ourselves as a Go Anywhere manager, meaning we have the freedom to own any asset class that we think offers good value for our clients. While our charter comes with meaningful restrictions on how much risk we can take both relatively (compared to the volatility of a blended benchmark) and absolutely (because of our stated rule of maintaining a diversified portfolio), we are a Go Anywhere portfolio strategy.
It is clear that the ‘biggest and best’ Go Anywhere funds and global macro hedge funds are having a difficult time getting bullish when the list of structural and cyclical risks seems endless. Readers are well aware of the litany of reasons why the stock market is currently fraught with risk: Europe, China, the U.S. fiscal cliff, declining earnings and revenues of U.S. corporations, policy makers gone mad, bond market bubbles, high frequency trading, rogue traders, Too-Big-to-Fail, etc. Nevertheless, the stock market has gone on a tear. As of Friday’s close the S&P 500 Index is up 13.27% for the year, including reinvested dividends. This has been especially unfortunate for Go Anywhere fund managers who have decided to stay on the sidelines as the market has rallied. Lauricella gives us several examples of giant, Go Anywhere funds that are missing the market.
The article about Micro Returns mentions the difficulties faced by several global macro hedge funds. While these funds grew by 66% ($462 billion) from the end of 2008 to the first quarter of 2012, in 2011 the average global macro fund lost 4.2% while the S&P 500 gained 2.1%, according to the Hedge Fund Research Group (HFR). This year it’s even worse. For the first six months of 2012, the average global macro fund lost 0.5% while the S&P 500 Index has roared higher gaining 9.5%. One fund that was unlucky enough to get mentioned in the article was Argonaut Capital, a $1.2 billion hedge fund. Argonaut lost -13.3% in 2011 and is down -4.5% through late July.
None of this is news here at Pinnacle. We routinely track our relative performance versus the Morningstar Balanced Fund Universe and several of the Go Anywhere funds that we consider a better universe of managers for us to compare ourselves to. The charts below show our one-year, three- year, and five- year performance versus the core, “buy and hold” style of managers represented by the balanced funds included, as well as our Go Anywhere universe (click them to enlarge). We think the charts speak for themselves. Obviously, over the five-year period — which includes the last bear market — we have considerably outperformed our benchmarks with less risk. When reviewing the past three years – while keeping in mind our mandate to manage risk for our clients over and above simply diversifying their portfolios — we believe we have captured the majority of the returns available to buy and hold investors while taking much less risk. At the same time, our investment process has allowed us to adjust to market conditions so that we have dramatically outperformed our competitive universe of Go Anywhere managers.
“Stuck” At Neutral?
One of the macro managers who spoke to Lauricella said “they are stuck at neutral in this market environment.” The notion of being “stuck at neutral” makes no sense in Pinnacle’s investment process. To us, “neutral” means that we have the same volatility as our benchmark. We run to neutral whenever we have low conviction in our market view. Pinnacle clients understand the implied risk and volatility of their investment strategy at neutral allocations — it simply means they should expect risk and returns comparable to their blended benchmark until our investment team has a higher level of conviction in our forecast. In fact, neutral implies a relative approach to portfolio risk and reward, and our clients can still earn solid returns in that state. This year is a good case in point. On an absolute basis Pinnacle DMG clients have gained more than 5% this year, even though we struggled on a relative return basis during the first quarter of the year.
Another one of the consultants Lauricella interviewed told him that even though the macro funds are doing a good job of managing risk, “sooner or later you need to eat the returns.” This old saw has been around forever, and refers to the notion of risk-adjusted returns. Simply put, when it’s time to pay the bills you need cash… not alpha. If you lose money absolutely, then losing less than your comparative benchmark isn’t very helpful. Any money manager who claims to manage risk in ways other than simply diversifying a portfolio will sooner or later be asked about “eating returns.” If you trail a bull market, no one cares about risk; in fact, as I’ve often stated in this space, in hindsight there is no such thing as risk. Risk is uncertainty, and when we look backwards there is only certainty. The manager who best managed risk is the manager with the highest returns. End of story.
Unfortunately, we don’t get to live in a world where money is managed after the fact. Today we have to deal with the litany of risks I mentioned earlier in this piece, and it is here that consumers of investment management must decide. Will they abandon the risk management techniques that will protect their capital in dangerous markets, or will they simply own a diversified portfolio and hope that the markets do not mistreat them?
It’s that simple, folks. If you’re willing to live with market risk and volatility at all times, then feel free to own them. You will find them very inexpensive, considering the numerous index mutual funds and ETFs that are available at low to no cost. However, if you want a different approach to risk management that at least gives your money manager a chance to protect your capital over and above simple diversification, then the choice becomes a lot harder. Find a manager with a GIPS compliant track record that encompasses both bull and bear markets. Make sure the track record was actually earned and is not hypothetical and back-tested, and confirm that the same investment team who earned the track-record is still the one calling the shots at the firm. Investigate the money manager’s process for decision making to make sure it isn’t dogmatic. And by all means, make sure that firm has a process for minimizing their investment mistakes (and the damage caused by them), because active Go Anywhere managers will surely make them.
Tom Lauricella does a great service in pointing out that actively managed funds have their own risks for investors. And while I can’t imagine recommending any other investment strategy, given the current landscape, the success of it comes down to the execution.