Over the years, macro hedge funds have been characterised by a group of extremely large firms with, historically at least, commensurately outsized track records of performance. A few years ago, some of these funds started to struggle a little, however, in part because they were just too big – actually executing a trade on behalf of investors took a monumental effort, which came with the obvious problem of signalling risk.
The answer for some firms was to hand money back to investors and go back to managing their own money only, or that of a small group of investors. This made them more nimble of course and solved the problem to a large degree. Since then a few of the bigger firms have effectively split their funds into two – one managing the firm’s staff’s own money, the other outside investors. This involves a serious compliance burden making sure that everything is done fairly and equitably and has inevitably led to whispers that the internal funds are doing better than the external and questions over whether this is right?
It seems, then, than being a huge fund had problems associated with it, especially when one takes into account the herd mentality of investors who think big is best.
There is another challenge for the bigger firms as well, according to an acquaintance of mine, with whom I had a conversation a week or so ago – and it involves style drift.
The need for benchmarking, assessment and comfort has meant over the years that investors have frowned upon style drift, and tricky conversations with allocators and investors are the inevitable result of implementing nuances (occasionally outright changes) to the trading strategy. Some of these conversations and desire to change the strategy have led to redemptions.
For the large investor looking to use the hedge fund space for what it was originally intended, a diversification investment, this attention to style drift makes sense. The investor wants to allocate money according to a set pattern established via correlation analyses and sundry other methodologies, all aimed at protecting them from outsize moves.
The trouble is, in today’s markets (and I should stress I am excluding equity markets here) a rigid strategy isn’t working. I have spoken with managers who tell me that they know in certain conditions their strategy is not going to work, but they are handcuffed by their mandate. They can go square of course, but how long are investors going to tolerate that for 1.5 and 15%?
I mentioned the news cycle in Monday’s column and that prompted a few of you to get in touch to say that it simply is too difficult establishing a position and sitting with it for any real length of time. It was also noted that, as I observed on Monday, the counter nature of the news cycle meant that what works for an hour, doesn’t for the next two, and then often works again. In other words, the move happens, but never, it seems, in a straight(ish) line.
There was a real sense of frustration over the inability to exploit every opportunity the markets offer, be it mean reversion, trading on a discretionary basis around events, or in a systematic way to exploit shorter term opportunities.
Except for one correspondent, who was very happy with life. They were in such a positive frame of mind mainly because they work for a small fund, with mostly internal investors and a few, selected, outside investors. The positive mindset was down to one simple fact, I was told, as my correspondent memorably put it, “We have no style!”
Effectively what this fund has done is go to investors as say, “back us as traders” not according to a fixed style. This is, obviously, quite a big ask of some investors, but there is apparently the track record to back it up and it actually got me thinking, isn’t this how hedge funds started in the first place? After all, what is “global macro” if it’s not the ability to take advantage of any and every situation?
A pertinent point was made, however, that this really only works in a small fund because they are not subject to the same processes, scrutiny and due diligence of a larger player – effectively they are not “institutionalised” by an investment industry which seems to become more risk averse (in operational terms) on a monthly basis.
It has bothered me for some time now that we have had a lot of event risk in markets for at least two years and it is not going away, and yet at the same time hedge fund performance hasn’t been that great overall. Obviously there are pockets of outstanding success and I wonder if the majority of this success emanates from firms that are not pigeon-holed?
I know I am not alone in thinking these have been really good traders’ markets for the past two years, but the problem is the traders to exploit them have been thin on the ground, be it because they are too slow in terms of decision making, or have their time horizons wrong.
It could be this is all the result of the changing market structure and the move towards technology-driven solutions. We could be witnessing the slow, painful demise of the trader, in favour of quant-driven, systematic models. If we are that is sad, but thankfully I can end on an upbeat note because I don’t believe it to be the case, or at least it will not always be the case.
Markets are cyclical and I am confident that if everyone went quant, so to speak, it would only be a matter of time before everything went horribly pear-shaped (official market terminology there). Markets thrive and are healthy on diversity. It could be at the moment that the macro, largely manual, trader is under pressure, but it will not disappear, because not only will a small number of firms and traders continue to do well, but as they learn more about the dominant strategy in markets, they can react accordingly and change how they trade to exploit the new opportunities.
The very fact they can change means they may not pick up a huge number of investors, and certainly not large mandates, but they will probably succeed, and into the bargain help maintain a healthy market ecosystem. You can’t build a market structure where everyone wins, there are always going to be firms on the up and firms on the down. My hope is that the imbalance never gets too big, like some hedge funds did a few years back, and markets become rather mundane, with the majority making and losing money at the same time.
Of course, if that happened then at least they would be performing to benchmark, but that is a subject for another day…