Global Macro Investing Style

May 14, 2007 9:40 PM

In my transition from researching the political economy of developing countries to methods of investment management, I’ve had to think carefully about how to apply years of experience and insight into emerging markets into investment theses that can be acted upon. Of the different investment styles, what is termed “Global Macro” investing seemed to be the investment style that fit my background best. However, my quantitative background pulled me in a different direction, with different dynamics, and I have been reconciling the conclusions that I have drawn from each.

Global Macro investing is an investment style that seeks to profit from large shifts in global (or, sometimes, national) economies. Probably the most famous practitioner of the global macro style is George Soros, who made a profit of $2 billion dollars in less than one week in 1992 by betting that the Bank of England would allow the pound-deutschemark exchange rate to depart from the trading band that had been necessary to keep the pound on track for European integration. To win this bet on skill rather than luck takes, among other things, an understanding of financial and economic drivers, an understanding of the political behavior of key actors, and an enormous stomach for risk, since the opportunity to gain $2 billion is also the opportunity to lose $2 billion.

The challenge of global macro investing, aside from the obvious question of doing correct political-economic analysis, is that good macro investment theses come relatively rarely. In Steven Drobny’s 2006 book, Inside the House of Money, several macro investors comment that they have only one or two major trading ideas per quarter. Even allowing for some professional modesty on the part of the interviewers, that amounts to perhaps 4-12 trading ideas per year. If one assumes that not all trading ideas are going to be correct or accurate all the time, a good global macro investor needs three key ingredients for success: 1) the ability to identify macro opportunities before the majority other market actors (vision), 2) a large probability of each vision being correct and timed correctly (skill), and 3) the ability to risk considerable capital on these views (stomach).

Robert Jaeger shows in his book, All About Hedge Funds, that global macro hedge funds (what he terms “global asset allocators”) have historically had both a high rates of return, about 17% (probably affected by both reporting and survivor biases), and a large dispersion in annual returns, with astandard deviation close to 11% (probably not so affected by these biases). This data covers the period from January 1990 to December 2001. The global macro funds in Jaeger’s study had a Sharpe Ratio - an indicator of how efficiently a strategy converts risk into return - in line with other major hedge fund strategies (approximately 1.0), and larger than many equity indices, but clearly, investors in macro funds had to have a fairly high tolerance for risk, because in any one year, there may be only 4-12 major actionable trading ideas, and small differences in how accurately the investor understands the world can easily translate into large gains or losses. It is one thing when a bad year means that your fund earned 8% instead of 12%; it’s entirely another matter when it means you lost 10% instead of gaining 30%. Even though it is possible to reduce those swings by investing only a part of one’s total assets in such a strategy, these wide swings will raise eyebrows.

Much quantitative investing, particularly relative value / market neutral styles, take a different approach to trading decisions. I’ll address some of these in a future blog, and then talk about how these approaches might interact profitably.

Bruce