Macro Managers Coming Through at Last

One of the disappoinments this year has been the performance of global macro managers. At the stage of half way through the year, it seemed that if a manager in this strategy had ridden the wave of QE2 inspired up-moves in equities and commodities then they gave it back by staying too long at the party, as the effects of monetary stimulus dissipated in May and from that month onwards. Those that lost a little in the 1Q may have made a bit back by mid-year, but there seemed to be too few managers that were able to ride markets in one direction and then the other with enough conviction or timing to make money across the whole of their books.

The pattern seemed to be if you made money early in the year you gave it back later. If a manager had a positive P&L in equities, they lost enough money in FX to be left around flat for the year. To be fair to the macro managers the market action this year, whether in fx or commodities or equities, has oftentimes not been in a pronounced trend for long. So it is that CTAs, the ultimate feeders off markets exhibiting trending behaviour, did not make good money until the last few months. Further, reversals have been sharp and volatility high - which makes it hard to hold onto gains even when they have been chiselled out of recalcitrant markets. The exceptions to the generality amongst global macro traders were those that tend to specialise in fixed income - the likes of Brevan Howard - for whom the trend was their friend for long enough for decent gains to be made by end of July.  

One of things that surprised me at the half way stage in the year was that so few macro managers had made much at all. Some of these big-picture managers tend to have core fixed income books, and others express their views on Chinese growth in the fx markets or in commodities. But they all may be positioned long or short, and they decide their own timing and sizing. So there is a lot of scope for the universe of macro managers to have completely different directional bets in the same market. Those that don't do much in energy, might concentrate on time spreads in softs or run a big book in credit trading. The point is they need not have correlated returns at all - in fact logically the universe of global macro managers should always have the biggest dispersion of returns amongst hedge fund strategy groups, and most of the time it does. By happenstance, taking all these different views and putting on unrelated trades across a wide selection of markets, hardly any macro managers had made good returns by the end of June this year. However the market gyrations of August and September have allowed a different story to be told for the period since.

Only this week Luke Ellis of Man Group was commenting that there was a very wide dispersion of manager returns amongst hedge funds in August. In September there was an historic extreme of dispersion of returns amongst managers running hedge funds. So for observers of, or investors in, hedge funds the returns of August and September become much more about which managers you were in, rather than which strategies you were allocated to. And practically it means that index or industry level returns for hedge funds for those two months start to be quite unrepresentative. We are well used to seeing headlines about "Hedge funds failing to deliver this month/on the year to date" based on index level returns, and sometimes (more usefully in this context) about returns across a hedge fund database being "good" or "bad" or generally different from returns on the underlying markets at an asset class level.

When the YTD numbers are close to zero, the next data point has a big impact on YTD returns. That is what has happened to hedge fund returns this year, and for some global macro funds in particular. The tables shown here are from "Absolute Return" magazine  and pick out amongst US-based managers the best returns produced last month. It is pleasing to see the marked presence of macro managers at the top of the rankings after the year they have had.  

These are good returns of specific managers in the global macro investment strategy. However, today I see that The Greenwich Investable Hedge Fund Indices give the index level returns for macro managers as -0.79% for September and -3.72% for the year so far. My experience of dealing with investors in hedge funds is that they are looking at what their specific hedge fund managers have done for them. There will be nearly no one who has experienced a return from their macro managers of -3.72% in the year to date (for reasons of position sizing and the timing of subscriptions and redemptions, if nothing else). Given the extreme dispersion of returns in September, and that macro managers have the widest dispersion of returns amongst any hedge fund investment strategy I can confidently say that no-one except an index investor has actually got a return of -0.79% from their macro managers last month. The inference is that the returns of the last two months will tell investors a lot about the quality of manager selection amongst their advisors and consultants, and amongst funds of funds. And not just in global macro.

Additional:

(Dec 7th 2011) Reuters posted an article headed "Global macro hedge fund returns fail to impress". The full article is posted here. The article mentions Louis Bacon's Moore Global Investments, Fortress Investment Group, Tudor Investment Corporation, Caxton Associates and Brevan Howard.

Testing Time Ahead for Funds of Hedge Funds

Flows into the hedge fund industry turned positive in the third quarter of last year. There have been monthly blips, but a positive trend of quarterly inflows has been in place since. This year there was a net investment of $13.7bn into hedge funds in the first quarter, followed by $9.5bn of inflows in the second quarter. In the last quarter Hedge Fund Research calculate that a net $19bn of new capital came into the industry.


The third quarter of 2010 was also a period of decent return from hedge funds, most of the gains coming in September. The positive returns for the year to date on top of the recovery of assets through net subscriptions has taken industry assets back to their previous peak of one and three-quarter trillion dollars.


It has been well recognised that flows have turned positive and that the majority of those flows have been captured by the largest single manager hedge fund groups - those overseeing $5bn or more. Some funds of hedge funds received new money in the second quarter - nearly a third of funds of funds had positive inflows then - but still in aggregate funds of funds have been losing capital for two years. Up to now. In the third quarter just finished, funds of hedge funds had a net inflow of $250m, according to HFR.

Net Subscriptions for Funds of Funds

The timing is indicative of the new reality of institutional investing in hedge funds. Just over a year on from net new subscriptions to single manager funds, multi-manager funds as a group received positive net subscriptions. The buyers of single manager hedge funds to this point were experienced institutional investors. If the first phase of taking hedge fund exposure is institutions getting exposure to the investment strategies through replication (not recommended, but it happens) or diversified funds of funds, then there are naturally other phases to follow. The second phase is likely to be the development of selection by the investing institution. This could be expressing a preference for a particular investment strategy, say distressed, or emerging market hedge funds, through selecting individual hedge funds, or allocating to a specialist fund of hedge funds.



Sometimes stage two is driven by a fee reduction exercise, or to utilise growing internal expertise, or sometimes even to put into practise an increase in allocations to alternatives or hedge funds specifically. Whatever the motivation, stage two is as likely to result in a reduction in the size of mandate managed by a fund of funds as an increase.



Institutions new to investing in hedge funds would be wise to utilise the services of a fund of hedge funds provider. So neophyte institutions and those adding to strategic allocations within their plans will have used funds of hedge funds in the growth phase of the industry to mid 2008.



In the last year we have moved from the trough of disillusionment* and are onto the slope of enlightenment for the hedge fund industry. In that time the investing institutions that are seasoned hedge fund investors have been pulling money from funds of funds to put the capital into single manager funds in aggregate.



We seem to be entering a new phase now. The recent positive net capital allocations to funds of hedge funds suggest one of two causes: that new buyers are coming into hedge funds and/or the more conservative of those existing institutional investors in hedge funds have started to add to their allocations. It is widely appreciated that the due diligence process has lengthened. So if it took 6 months from first meeting to filling in subscription documents it now takes 9 months. Starting a new hedge fund investment programme for an institution via a fund of funds might take a year or more as there is double diligence to complete, at the fund of funds level and at the single manager level.



If this hypothesis is correct funds of hedge funds should have more and larger mandates heading their way from here on. This will be tested over the rest of 2010 (particularly in December, a key month for redemptions) and will be confirmed by positive flows in the first half of 2011.



Additional: Pictet & Cie, the Swiss private bank, confirmed that it had had net inflows of $340m into its fund of hedge funds this year bringing the total AUM to $8.2bn at the end of September.

*http://www.thehedgefundjournal.com/magazine/200907/manager-writes/through-the-trough-of-hedge-fund-disillusionment-.php

Replication out at AHL

The FINalternatives website carried a story from Financial News on AHL this week:


“The Man Group’s flagship AHL strategy has seen eight employees, including its lead algorithmic trading technologist and an academic hedge fund-replication specialist, leave the firm.


“Chetan Kotwal, the technologist, and Helder Palaro, the hedge fund-replication expert, have both left Man. Another academic, Harry Kat, has also left, along with five other more junior employees: researchers Yochen Maydt and Steven Piron, traders Tom Ryan and Rebecca Aston, analyst Will England and algorithmic trading systems developer.”


The news is interesting that AHL were seeking to build a hedge fund return replication capability. Parent Man Group sold lots of product which combined the AHL Fund with other Man Group single-manager or multi-manager fund products. The guaranteed funds were often a combination of AHL with fund of funds Glenwood. Glenwood returns were never fantastic, so eventually other funds were tried in combination with AHL, and Glenwood was subsumed into Man Glenwood.


Has AHL been working on hedge fund replication strategies to enable Man Group to offer AHL in a guaranteed product in combination with industry typical returns? If so it would not reflect well on the confidence of Man Group management in other in-house managers, either single manager or multi-manager.


As long ago as 2006 Dutch academic Harry Kat suggested that investors who wanted higher returns from hedge fund investments should fire their overpaid fund managers and replicate the funds themselves using mechanical futures trading strategies. At that time his research suggested that the synthetic funds he and Helder Palaro designed would have outperformed real funds of hedge funds 82% of the time. Kat’s prediction then was that the alternative investment market would move rapidly away from active management over the following 10 years, and synthetic hedge funds would represent around 40% of the market by 2016.


It will be interesting to hear whether actual capital invested in hedge fund replication strategies have outperformed funds of hedge funds 82% of the time since 2006, and particularly in the last two years.


Please use the comment fields below to provide an answer and I will moderate an informed discussion.