By Max Darnell and Jeppe Ladekarl
It has been an environment that would have seemed perfect for macro. Macro phenomena have dominated investment returns throughout the credit crisis and its aftermath, and opportunities for macro investing seemed, at least on the surface, to be plentiful.
So why have returns from macro investment been less successful than expected and, more recently, mostly disappointing?
Our thesis is that asset classes most influenced by central bank decisions or government responses to the credit crisis, and the resulting economic turmoil, have been the ones most difficult to trade by managers whose decisions are driven by economic and fundamental drivers of return.
This means that trading in bonds and equities has been impacted the most, while currencies and commodities have been impacted the least. With bonds often the most actively traded instruments by macro managers (after currency), we would expect this to have been problematic.
Looking forward, we are optimistic that the efficacy of trading sovereign debt futures will improve as central banks incrementally reduce their direct influence on the long end of the yield curve. Macro managers should begin to see improvement, at least in this aspect of their performance, as fixed income as an asset class normalises.
The trading of equity indexes is a different matter, however. This is an area of investment activity that has also been tough, as policy decisions have unduly rewarded investments into markets with deteriorating fundamentals. Looking forward, we are also concerned about the challenges we face in trading equity indexes on a fundamental basis if governments continue to increase their appetite for regulatory and legislative intervention.
Beyond fixed income and equity, the reflection of fundamental and economic macro dynamics in market prices has not only been more normal, but at times, better than normal. We see that in currency markets, for example.
It is worth explaining what we mean by “fundamental and economic dynamics”. Simply put, in any free market, prices are set where supply intersects with demand. What is supplied is a set of assets that carry various characteristics. Differences in investors’ views as to the nature and magnitude of these characteristics only occur because the approaches to estimating, forecasting, and measuring those characteristics vary. Were investors to use the same methods and inputs, what is supplied would be universally agreed upon. That does not mean that they would agree upon market prices.
Intrinsic value derives from the essence of the item itself, and is strictly independent of anything else including its usefulness to others. It is in the value of those characteristics where substantive differences are expected between investors. Two investors can agree on what the asset characteristics are; but at the same time, they are likely to disagree on how valuable those characteristics are in the pursuit of their own objectives. Their demand differs.
Demand for currencies derives from those who trade currency as a pass-through asset when transacting internationally in financial assets, goods, and services. Demand also derives from central banks, hedgers, and traders who are seeking to profit from currencies. What we do is evaluate changes in the characteristics of what is supplied and, at the same time, determine what motivates changes in the demand. It is in the relative stability of the intrinsic value and the normalcy of changes in demand where we have found solid macro investment opportunities.
Despite current trials and tribulations, we generally see the environment for macro investing as improving. For currency, the quintessential macro asset with its ability to serve as a virtual weather vane for macro events, the future seems especially promising.
Max Darnell is chief investment officer and Jeppe Ladekarl is a director in the Global Macro team at First Quadrant
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