Download Alternative Investments Global Macro Strategy

Alternative Investments
and the
Global Macro Strategy
Insights for Individual Investors
Dr. James Thorne, Ph.D.
Chief Capital Market Strategist & Senior
Portfolio Manager
Morgan Pampe, CFA, MFIN
Portfolio Manager
Introduction
April 2017
Malcom Gladwell (Gladwell, 2000) introduced the concept the “Tipping Point”, the point at which a series of small
changes or incidents become important enough to cause a larger significant evolutionary change. For many the dual
crises of the popping of the Technology Bubble in 2000 and the Global Financial Crisis in 2008, created a tipping point
causing modern portfolio management to experience a significant regime change and evolve. Portfolio Management1
theories were developed in the mid to late 1960’s and taught at universities. They were based on the simple assumption
that markets were efficient and investors were rational, non-emotional, decision makers. In that controlled environment,
optimal portfolio performance and diversification was largely achieved by using the traditional asset allocation mix of
60% stocks and 40% bonds.
The past decade revealed that correlations between assets have a tendency to go to one in times of stress, decision
makers’ actions are far from rational and theories developed in the 1960’s did not protect portfolios from experiencing
significant draw-downs during crisis periods. In response to such crises, many investors concluded that if one cannot
generate returns or control risk, it’s best to focus on costs. We have seen an alternative interpretation of this cognitive
error, which is congruent with how institutional investors have reacted to such events. The better solution would be
the introduction of alternative investments into the asset allocation portfolio.
The new optimal portfolio is now, 50% equities, 30% bonds and 20% alternatives. The introduction of alternatives
increased the risk adjusted returns, minimizing draw-downs during crisis periods for the portfolio. Simply put, the
introduction of alternatives allows for the capture of what is now being referred to as “Crisis Alpha”2. To minimize the
realization of draw-down and increase the risk adjusted return of a traditional 60/40 portfolio, our research reveals one
solution would be for Portfolio Managers to introduce a global macro hedge style into their portfolios.
Problem
When investors are asked what they want from their investments, a common reply is “I want high returns with no
risk”. In lieu of the 10% GIC no longer being available, we are left to advise that an investor’s goal should be to optimize
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the allocation of their capital among a set of potential investments. The objective in the portfolio construction phase is
to generate an optimal tradeoff between risk and return. The portfolio optimization problem is simple enough; choose
an optimal mix of assets that maximizes return while minimizing risk. The key to solving this problem is not to lose
any money, or as Portfolio Managers say, minimize the draw-down in the portfolio, (specifically in periods of negative
crisis, minimizing losses enhances the risk adjusted return of the portfolio over time). Unfortunately, the portfolio
theory that was developed in the 1960’s failed to achieve its key requirement during the last two negative crisis events,
the popping of the Technology Bubble and the Global Financial Crisis. A focus on low correlation is imperative to
improve the consistency of returns so that investment goals can be achieved. The traditional asset classes did not
provide the benefits of diversification that were expected during these periods.
Solution
The lower the decline and less time it takes to recover from periods of loss (low draw-down), the better the chance
the portfolio will deliver the expected compounded returns. Through efficient diversification, a portfolio’s draw-down
can be minimized and over time maximize the power of compounding. The data presented in Table 1 compares two
portfolios, the classic 60% stock, 40% bond portfolio to a portfolio of 50% stock, 30% bond and 20% alternative. The
sample period is from the beginning of January 1, 2000 to December 31, 2016. The results show that the portfolio
which introduces alternative investments, achieves a higher rate of return with a lower level of risk. Both portfolios
employed the S&P 500 Index for stocks and the Barclay’s Aggregate Bond Index. The alternative asset in this simple
experiment was the Global Macro Index. The conclusion that was reached is that Portfolio Managers can optimize
the performance of their portfolio, have higher returns, less volatility and smaller draw-downs, when alternatives are
added to a traditional 60/40 asset allocation portfolio.
Table 1: Adding Alternatives to a Portfolio Increases its Efficiency
January 2000 - December 2016
Mean per Year
Standard Deviation
Sharpe Ratio
Largest Draw-down
Months to Recovery
S&P 500
3.6%
14.9%
.17
-52.4%
49
*60/40
4.5%
6.8%
.51
-22.9%
20
**50/30/20
5.4%
5.4%
.81
-14.4%
9
Global Macro
8.2%
4.0%
1.77
-3.9%
5
* “60/40” is a portfolio that contains 60% S&P 500 Index and 40% Barclay’s Aggregate
Government Bond Index.
** “50/30/20” is a portfolio that contains 50% S&P 500 Index, 30% Barclay’s Aggregate
Government Bond Index and 20% Barclay’s Global Macro Hedge Strategy Index.
Source: Bloomberg
When an analysis is done comparing the different alternative strategies, the evidence presented in Table 2 suggests,
using the Sharpe Ratio3 as our guide, that the Global Macro Strategy generates the best risk adjusted returns. In addition,
the Global Macro Strategy also generates the smallest draw-down at only -3.9% with 5 months recovery.
The Global Macro Strategy is a go anywhere strategy, having the ability to invest in stocks, bonds, currencies,
commodities, physical precious metals, both long and short, options and futures, It has the unique ability to participate
in a bull market, as well as benefiting from bear markets. It is flexible enough to profit from rapidly changing regimes,
themes, or political movements that may occur in the global economy from time to time. Global Macro Managers
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Tel: 416-593-1798 | 1-800-256-2441 | [email protected] | www.caldwellinvestment.com
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assume that somewhere and somehow there is a way to profit from the current global environment. During periods of
crisis, traditional Portfolio Managers may be constrained by investment mandates, institutional forces4, or behavioural
reasons. This can result in forced action that collectively generates predictable opportunities that can be exploited if
the Portfolio Manager has the flexibility, and the ability to identify and adapt to the new reality. Markets follow cycles
and it is the ability of Global Macro Managers to capture what we call “Crisis Alpha” that sets this strategy apart. We
believe that crisis can be taken advantage of in many ways. A change in political leadership that opens up a country to
foreign capital, will be seen positively to the global investment community and if anticipated, could create significant
value to a portfolio.
Table 2: Comparison of Alternative Strategies
January 2000 December 2016
Hedged CTA
Global Macro
Equity Neutral
Equity L/S
Multi Strategy
Distressed
Mean per
Year
3.9%
8.2%
4.0%
5.8%
7.1%
7.4%
Standard
Deviation
6.4%
4.0%
2.8%
5.8%
4.5%
7.0%
Sharpe
Ratio
.45
1.77
1.11
.83
1.36
.92
Largest
Months to
Draw-down Recovery
-9.9%
15
-3.9%
5
-6.3%
35
-14.3%
13
-19.3%
13
-35.3%
23
Information presented was calculated using Barclay’s Hedge Fund Index data.
Source: Bloomberg
Conclusion
The goal of Global Macro is to generate controversial investment themes that can be backed up by logic and research
which creates value for the unit holders of the portfolio. Global Macro Managers benefit from periods of structural
change. The objective of the Manager is to spot anomalies, mis-priced assets, major shifts in economic patterns, and
political movements. The first building block of the strategy is top down macro-economic analysis. The best managers
have the unique characteristic of having a higher degree in economics5 coupled with the ability to value assets.
Incorporating a Global Macro Alternative Strategy to a portfolio compliments traditional bottom-up strategies, such as
long only equity or fixed income. Simply put, adding alternatives to the classic asset allocation portfolio increases the
risk adjusted return of the portfolio. When the Portfolio Managers are engaged in the portfolio construction phases,
they should seriously consider the benefits that a Global Macro Strategy will give in terms of portfolio optimization.
Caldwell Investment Management Ltd. | 150 King Street W., Suite 1702, P.O. Box 47 | Toronto, ON M5H 1J9
Tel: 416-593-1798 | 1-800-256-2441 | [email protected] | www.caldwellinvestment.com
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Endnotes
The efficient market hypothesis assumed decision makers were rational and did not make mistakes. Furthermore, all
information was contained in stock process and that insurance could be bought to perfectly insure the portfolio. Diversification
was achieved using Morningstar style boxes, i.e. growth vs. value (price to book), size, and where the head office of the company
was located.
2
Crisis alpha is the return created by investing in a controversial investment. It can be captured by the asset either
appreciating or deprecating in value. For example, buying assets in a country exiting a political crisis, or shorting an asset when a
country is entering into a political crisis.
3
Indicates the average return minus the risk free return divided by the standard deviation of the return of the investment.
The measure is used to compare performance when adjusting for risk.
4
For example, requirements to be fully invested during the financial crisis.
5
With a discretionary global macro, traditional bottom up financial analysis takes a back seat to top down economic and
geopolitical analysis.
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Reference
Gladwell, Malcolm. The tipping point: how little things can make a big difference. London: Abacus, 2015.
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Tel: 416-593-1798 | 1-800-256-2441 | [email protected] | www.caldwellinvestment.com
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