Morgan Stanley
  • Investment Management
  • Dec 13, 2018

Global Macro's Unique Advantage During Challenging Markets

Amid increased volatility and broader market uncertainty, investors are looking for strategies with a track record for generating strong risk-adjusted returns.

Following a period of relative stability, investors are now confronting a litany of potential risks globally, from rising U.S. interest rates and increased volatility in equity markets to escalating trade tensions, political unrest and high valuations across a broad set of asset classes.

In response, investors are seeking out strategies that have a track record for generating strong risk-adjusted returns in challenging markets. For certain investors, global macro strategies could be one component of a well-diversified portfolio. By taking positions—both long and short—in stocks, bonds, commodities, currencies and other assets, these strategies have the potential to outperform traditional approaches when markets are in flux.

“The thinking behind global macro investing is to capitalize on market dynamics unfolding anywhere on the globe and be in any market or asset class where there is opportunity," says Robert Rafter, Head of Discretionary Global Macro at Morgan Stanley Investment Management Alternative Investment Partners. “This means not just anticipating the next inflection point in a particular economy or a political change, but also being able to anticipate how various markets will respond to new developments."

Strength and Diversity in Adversity

Global macro managers employ many different investment styles and analytical inputs, across varying time horizons, but a common thread is to seek excess return by timing their exposures to different segments of the globe. While this approach tends to work well in a range of market environments and global macroeconomic scenarios, global macro managers have historically posted their best relative returns during market dislocations.

Between Jan. 1, 1990, and October 31, 2018, for example, the HFRI Macro Index delivered positive returns in 23 out of 28 full calendar years, according to Hedge Fund Research, Inc. Moreover, the index, which is a proxy for global macro strategies, returned an average of 9.71% a year—or nearly 10 basis points more per year than the Standard & Poor's 500—and with only half the volatility of the broader market.

In addition, global macro strategies have historically had low correlations to equity and bond markets—offering additional potential diversification benefits.

The conventional wisdom on asset allocation has been to spread one's bets across stocks, bonds and a smattering of alternatives, such as gold, real estate or commodities. Yet, the global financial crisis and other periods of discord revealed the shortcomings of traditional diversification strategies. 

 

Global Macro Performance During Crisis Periods (01/1998 - 10/2018)

Source: Hedge Fund Research, Inc. for HFRI indices; Bloomberg for all other indices

During the most devastating months of the crisis, in September and October 2008, stocks and bonds fell in tandem. The HFRI Macro Index returned +0.40% during this period.

 

HFRI Macro and S&P 500 12-month Rolling Correlation
(01/1990-10/2018)

Source: Hedge Fund Research Inc. and Bloomberg

Although global macro is designed to reduce overall portfolio volatility, challenging markets often play to their strengths. Again, that's because global macro managers aim to exploit inefficiencies, such as investor behavioral biases, divergent global business cycles, differences in central banking policy, and monetary policy shifts.

“Because the strategies themselves are not biased with respect to region or asset class, they can go where the opportunities are," says Rafter. “Meanwhile, macro strategies play in the most liquid parts of the market, so they have the potential to capture sudden and large changes in the market or market dynamics."

Manager Selection Is Critical

Global macro managers typically make allocation decisions based on changes in macroeconomic outlooks, policies or investor perception. Exactly how they arrive at these views varies widely. Fundamental managers, for example, evaluate opportunities based on such criteria as relative valuations, economic forecasts, fiscal policy, and outlooks for interest rates or currencies. Technical managers, meanwhile, might rely primarily on quantitative models that spot predictive signals based on historic market price patterns.

The same is true for how they execute their ideas. Systematic managers tend to adhere to a rules-based approach that determines weightings, timing and position sizes. Discretionary managers, on the other hand, typically form and execute their views by combining analytical tools and processes with qualitative assessments and experience.

Global macro strategies have the potential to enhance risk-adjusted performance and improve overall diversification when added to a portfolio of traditional investments, alternative investments, or both. The challenge, however, is selecting global macro managers with the skill to generate returns on a consistent basis across market cycles.

For this reason, we believe many investors opt for multi-manager investment vehicles run by specialists in manager selection, portfolio construction, dynamic asset allocation and risk management techniques.  Such vehicles mitigate the idiosyncratic risk that accompanies standalone hedge fund investments by providing diversification across managers, strategies and investment styles.

“For investors, this should translate to a more effective and diversifying exposure than what they might see by investing in only a few global macro managers," Rafter notes. In the end, that can provide stronger risk-adjusted returns and better ballast for a portfolio, no matter what the macroeconomic backdrop.

For more information on Morgan Stanley Investment Management's approach to Global Macro investing, ask your Morgan Stanley representative or Financial Advisor for more details or visit the AIP Hedge Fund Team page.

Risk Considerations

The following are among the risks applicable generally to a portfolio of hedge fund investments:

Reliance on Third-Party Management. The goal of investing in a portfolio of hedge funds managed by an investment adviser is to seek capital appreciation. Hedge funds selected for the portfolio are managed by third-party managers unaffiliated with an investment adviser over which an investment adviser does not exercise control.

Wide Scope of Investment Options Available to Third-Party Managers. Hedge funds may invest and trade in a wide range of instruments and markets and may pursue various investment strategies. Although hedge funds will primarily invest and trade in U.S. and non-U.S. equity and debt securities, they may also invest and trade in equity-related instruments, currencies, financial futures and debt-related instruments. In addition, hedge funds may sell securities short and use a wide range of other investment techniques. Hedge funds are generally not limited in the markets in which they may invest, either by location or type, such as U.S. or non-U.S. markets or large- or small-capitalization companies, or in the investment discipline which their investment managers may employ, such as value or growth strategies or bottom-up or top-down analysis. Hedge funds may use various investment techniques for hedging and non-hedging purposes. A hedge fund may, for example, sell securities short, purchase and sell options and futures contracts, and engage in other derivative transactions. The use of these techniques may be an integral part of the hedge fund’s investment strategy and may involve certain risks. Hedge funds may use leverage, which also entails risk.

No Assurance of Returns. The investment program of a portfolio of hedge funds is speculative and entails substantial risks. No assurance can be given that its investment objective would be achieved. Its performance depends upon the performance of the hedge funds included in the portfolio and upon the ability of the Investment Adviser effectively to select hedge funds and allocate and reallocate the portfolio’s assets among them. Each hedge fund’s use of leverage, short sales and derivative transactions, in certain circumstances, can result in significant losses, volatility, or both.

Performance-Based Compensation. In addition to asset-based fees based on the hedge fund’s net assets under management, a hedge fund’s investment manager will typically charge each of the hedge fund’s investors a performance or incentive fee or allocation based on net profits of the hedge fund which it manages. Similarly, in addition to asset-based fees based on the portfolio’s net assets, the Investment Adviser or one of its affiliates will also receive performance-based compensation (the “Performance Incentive”). The receipt of a performance or incentive fee or allocation by a hedge fund’s investment manager or of the Performance Incentive by the Investment Adviser or one of its affiliates may create an incentive for the hedge fund’s investment manager or the Investment Adviser, respectively, to make investments which are riskier or more speculative than those which might have been made in the absence of such an incentive.

Lack of Transparency. Hedge funds are not registered as investment companies with the U.S. Securities and Exchange Commission (the “SEC”) under the Investment Company Act of 1940 (the “ICA”), and investors in hedge funds will not have the benefit of the protections afforded by the ICA to investors in registered investment companies.

Although the Investment Adviser will periodically receive information from each hedge fund in which the portfolio is invested regarding such hedge fund’s investment performance and investment strategy, the Investment Adviser may have little or no means of independently verifying this information. Hedge funds are not contractually or otherwise obligated to inform their investors of details surrounding proprietary investment strategies. In addition, the Investment Adviser has no control over the investment management, brokerage practices, custodial arrangements or operations of hedge funds and must rely on the experience and competence of each hedge fund’s investment manager in these areas.

Multiple Levels of Fees and Expenses. By investing in a portfolio of hedge funds managed by the Investment Adviser, an investor bears its proportionate share of the asset-based fees and the Performance Incentive payable to the Investment Adviser and any of its affiliates, as the case may be, as well as other expenses of the portfolio. An investor, however, also indirectly bears its proportionate share of the asset-based fees, performance or incentive fees or allocations, and other expenses borne by investors in the hedge funds included in the portfolio. An investor which meets the eligibility conditions imposed by the respective hedge funds included in the portfolio, including minimum initial investment requirements which may be substantially higher than those imposed by any fund, could avoid the extra layer of fees and expenses by investing directly in those hedge funds.

Independence of Hedge Funds’ Investment Managers. A hedge fund’s investment manager will receive any performance or incentive fees or allocations to which it is entitled, without regard to both the performance of the other hedge funds in the portfolio and the performance of the overall portfolio. An investment manager to a hedge fund with positive performance may receive compensation, even if the overall portfolio’s aggregate returns are negative.

Potential for Increased Transactions Costs. Investment managers of the hedge funds included in the portfolio make investment decisions independently of each other. Consequently, at any particular time, one hedge fund in the portfolio may be purchasing interests in an issuer which at the same time are being sold by another hedge fund in the portfolio. Investment by hedge funds in this manner could cause the overall portfolio to incur certain transaction costs indirectly without accomplishing any net investment result.

Limited Liquidity of Hedge Funds. Additional investments in, or withdrawals from, the hedge funds in the portfolio may be made only at certain times, as specified in the governing documents of the respective hedge funds. As a result, before investments in hedge funds are effected or in furtherance of the portfolio’s objectives generally, some assets held in the portfolio may temporarily be from time to time cash, cash equivalents, or high-quality fixed-income securities and money market instruments (whether or not managed by affiliates of the Investment Adviser).

Limited Voting Rights of Investors. A hedge fund typically restricts the ability of its investors to vote on matters relating to the hedge fund. As a result, investors in the hedge fund will have no say in matters which could adversely affect their investment, via the portfolio, in the hedge fund.

Distributions in Kind. Hedge funds may distribute securities in kind to investors. Securities distributed in kind may be illiquid or difficult to value. In the event that a hedge fund were to make such a distribution in kind to a Fund, the Investment Adviser would seek to dispose of the securities so distributed in a manner which is in the best interests of such Fund.

Reliance on Third-Party Managers with Respect to Asset Valuation. Certain securities in which a hedge fund invests may not have a readily ascertainable market price and will be valued by the hedge fund’s investment manager. Such a valuation generally will be conclusive, even though the hedge fund’s investment manager may face a conflict of interest in valuing the securities, inasmuch as the value of such securities will affect the compensation payable to the hedge fund’s investment manager. In most cases, the Investment Adviser will have no ability to assess the accuracy of any such valuation. In addition, the net asset values or other valuation information received by the Investment Adviser from hedge funds will typically be estimates only, subject to revision until completion of the annual audits of the respective hedge funds. Revisions to the gain and loss calculations will be an ongoing process, and no net capital appreciation or depreciation figure can be considered final until completion of the annual audits of the respective hedge funds. 

GLOSSARY

Alpha: “Alpha” is a risk-adjusted measure of the so-called “excess return” on an investment. It is a common measure of assessing an active manager’s performance.

Beta: “Beta” is a measure of the sensitivity of a manager’s returns to the performance of the markets. It is an estimate in percentage terms of, all else equal, how a one-percentage point change in a particular market (or index) will be reflected in the manager’s returns.

Correlation: Statistical measure of the degree to which the movements of two variables are related.

Commodities: A basic good used in commerce that is interchangeable with other commodities of the same type. Commodities are most often used as inputs in the production of other goods or services. The quality of a given commodity may differ slightly, but it is essentially uniform across producers. When they are traded on an exchange, commodities must also meet specified minimum standards, also known as a basis grade.

Dispersion: A term used in statistics that refers to the location of a set of values relative to a mean or average level. In finance, dispersion is used to measure the volatility of different types of investment strategies. Returns that have wide dispersions are generally seen as more risky because they have a higher probability of closing dramatically lower than the mean. In practice, standard deviation is the tool that is generally used to measure the dispersion of returns.

Foreign Exchange: The exchange of one currency for another, or the conversion of one currency into another currency. Foreign exchange also refers to the global market where currencies are traded virtually around-the-clock. The term foreign exchange is usually abbreviated as “forex” and occasionally as “FX.”

Fundamental Inputs (basis for investment views): Use valuation techniques and macroeconomic variables as inputs to investment decisions.

Systematic Style (application of views): No human intervention in trade generation.

Technical Inputs (basis for investment views): Employ market-based (e.g., price and volume) information as inputs to trading decisions.

Volatility: A statistical measure of the tendency of a market or security to rise or fall sharply within a period of time – usually measured by standard deviation.

Important Disclosures

The views expressed herein are those of the Investment team and are subject to change at any time due to changes in market and economic conditions. The views and opinions expressed herein are based on matters as they exist as of the date of preparation of this piece and not as of any future date, and will not be updated or otherwise revised to reflect information that subsequently becomes available or circumstances existing, or changes occurring, after the date hereof. The data used has been obtained from sources generally believed to be reliable. No representation is made as to its accuracy.

Information regarding expected market returns and market outlooks is based on the research, analysis, and opinions of the investment team. These views do not represent views of other Investment teams at MSIM or those of the firm as a whole. These conclusions are speculative in nature, may not come to pass, and are not intended to predict the future of any specific investment.

Certain information contained herein constitutes forward-looking statements, which can be identified by the use of forward-looking terminology such as “may,” “will,” “should,” “expect,” “anticipate,” “project,” “estimate,” “intend,” “continue” or “believe” or the negatives thereof or other variations thereon or other comparable terminology. Due to various risks and uncertainties, actual events or results may differ materially from those reflected or contemplated in such forward-looking statements. No representation or warranty is made as to future performance or such forward-looking statements.

Past performance is not indicative of nor does it guarantee comparable future results.

This piece has been prepared solely for informational purposes and is not an offer, or a solicitation of an offer, to buy or sell any security or instrument or to participate in any trading strategy.

Persons considering an alternative investment should refer to the specific fund’s offering documentation, which will fully describe the specific risks and considerations associated with a specific alternative investment.

Alternative investments are speculative and include a high degree of risk. Investors could lose all, or a substantial amount of, their investment. Alternative investments are suitable only for long-term investors willing to forgo liquidity and put capital at risk for an indefinite period of time.

Alternative investments are typically highly illiquid—there is no secondary market for private funds, and there may be restrictions on redemptions or the assignment or other transfer of investments in private funds. Alternative investments often engage in leverage and other speculative practices that may increase volatility and risk of loss. Alternative investments typically have higher fees and expenses than other investment vehicles, and such fees and expenses will lower returns achieved by investors.

Funds of funds often have a higher fee structure than single manager funds as a result of the additional layer of fees. Alternative investment funds are often unregulated and are not subject to the same regulatory requirements as mutual funds, and are not required to provide periodic pricing or valuation information to investors. The investment strategies described in the preceding pages may not be suitable for your specific circumstances; accordingly, you should consult your own tax, legal or other advisors, at both the outset of any transaction and on an ongoing basis, to determine such suitability.

Morgan Stanley does not render tax advice on tax accounting matters to clients. This material was not intended or written to be used, and it cannot be used with any taxpayer, for the purpose of avoiding penalties which may be imposed on the taxpayer under U.S. federal tax laws. Federal and state tax laws are complex and constantly changing. Clients should always consult with a legal or tax advisor for information concerning their individual situation.

The information contained herein may not be reproduced or distributed. This communication is only intended for and will only be distributed to persons resident in jurisdictions where such distribution or availability would not be contrary to local laws or regulations.

Index data is provided for illustrative purposes only. Indices do not include any expenses, fees or sales charges, which would lower performance. Indices are unmanaged and should not be considered an investment. It is not possible to invest directly in an index.

While the HFRI Indices are frequently used, they have limitations (some of which are typical of other widely used indices). These limitations include survivorship bias (the returns of the indices may not be representative of all the hedge funds in the universe because of the tendency of lower performing funds to leave the index); heterogeneity (not all hedge funds are alike or comparable to one another and the index may not accurately reflect the performance of a described style); and limited data (many hedge funds do not report to indices, and the index may omit funds, the inclusion of which might significantly affect the performance shown. The HFRI Indices are based on information self-reported by hedge fund managers that decide on their own, at any time, whether or not they want to provide, or continue to provide, information to HFR Asset Management, L.L.C. Results for funds that go out of business are included in the index until the date that they cease operations. Therefore, these indices may not be complete or accurate representations of the hedge fund universe, and may be biased in several ways.

Trade examples are provided for illustrative purposes only to demonstrate the investment process for Global Macro and should not be considered a recommendation to participate in the trades mentioned. There is no guarantee that the strategies mentioned will perform well in the future. The views expressed in this article (the “Article”) are those of the author(s) as of the date this Article was written and not as of any other date. The information presented in this Article does not in any way constitute, and should not under any circumstances be construed or relied upon, as investment advice. Furthermore, this Article is not an offer, or a solicitation of any offer, to buy or sell any security or instrument or to participate in any investment or trading strategy. No representation or warranty, expressed or implied, is made or can be given with respect to the accuracy or completeness of the information in this Article. Morgan Stanley does not render advice on tax and accounting matters. Federal and State tax laws are complex and constantly changing. You should always consult your legal or tax advisor for information concerning your individual situation before making any investment.

This presentation was prepared in the first instance by Morgan Stanley Investment Management and was authorized for publication in the UK by Morgan Stanley Private Wealth Management Limited, authorized and regulated by the Financial Services Authority. This presentation is a marketing communication. It does not constitute investment research and is not a product of Morgan Stanley and /or its affiliates’ Research Department(s) and you should not regard it as a research report. This presentation has been prepared solely for informational purposes and is not an offer, or a solicitation of an offer, to buy or sell any financial instrument or participate in any trading strategy.

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INDEX DESCRIPTIONS

Hedge Fund Research, Inc. (HFRI) Macro (Total) Index. The HFRI Macro (Total) Index consists of investment managers which trade a broad range of strategies in which the investment process is predicated on movements in underlying economic variables and the impact these have on equity, fixed income, hard currency and commodity markets. Managers employ a variety of techniques, both discretionary and systematic analysis, combinations of top-down and bottom-up theses, quantitative and fundamental approaches and long and short-term holding periods. Although some strategies employ RV techniques, Macro strategies are distinct from RV strategies in that the primary investment thesis is predicated on predicted or future movements in the underlying instruments, rather than realization of a valuation discrepancy between securities. In a similar way, while both Macro and Equity Hedge managers may hold equity securities, the overriding investment thesis is predicated on the impact movements in underlying macroeconomic variables may have on security prices, as opposed to EH, in which the fundamental characteristics on the company are the most significant are integral to investment thesis, holding period, concentrations of market capitalizations and valuation ranges of typical portfolios.

Hedge Fund Research, Inc. (HFRI) Relative Value (Total) Index. The HFRI Relative Value (Total) Index consists of investment managers who maintain positions in which the investment thesis is predicated on realization of a valuation discrepancy in the relationship between multiple securities. Managers employ a variety of fundamental and quantitative techniques to establish investment theses, and security types range broadly across equity, fixed income, derivative or other security types.

Hedge Fund Research, Inc. (HFRI) Event Driven (Total) Index. The HFRI Event Driven (Total) Index consists of investment managers who maintain positions in companies currently or prospectively involved in corporate transactions of a wide variety including but not limited to mergers, restructurings, financial distress, tender offers, shareholder buybacks, debt exchanges, security issuance or other capital structure adjustments. Security types can range from most senior in the capital structure to most junior or subordinated, and frequently involve additional derivative securities. Event Driven exposure includes a combination of sensitivities to equity markets, credit markets and idiosyncratic, company specific developments. Investment theses are typically predicated on fundamental characteristics (as opposed to quantitative), with the realization of the thesis predicated on a specific development exogenous to the existing capital structure.

Hedge Fund Research, Inc. (HFRI) Equity Hedge (Total) Index (long/short equity). The HFRI Equity Hedge (Total) Index consists of managers who maintain positions both long and short in primarily equity and equity derivative securities. A wide variety of investment processes can be employed to arrive at an investment decision, including both quantitative and fundamental techniques; strategies can be broadly diversified or narrowly focused on specific sectors and can range broadly in terms of levels of net exposure and leverage employed.

Barclay CTA Index: The Barclays CTA Index is a leading industry benchmark of representative performance of commodity trading advisors. The index is unweighted and rebalanced at the beginning of each year. To qualify for inclusion in the CTA Index, an advisor must have four years of prior performance history. Additional programs introduced by qualified advisors are not added to the Index until after their second year. These restrictions, which offset the high turnover rates of trading advisors as well as their artificially high short-term performance records, ensure the accuracy and reliability of the Barclay CTA Index.

Barclays Global Aggregate Index (Hedged USD): The Barclays Global Aggregate Index provides a broad-based measure of the global investment grade fixed-rate debt markets. Total Returns shown in hedged USD.

S&P 500 Total Return Index: The S&P 500 Total Return Index is an index that consists of 500 stocks chosen for market size, liquidity and industry group representation. The S&P Index is a market value weighted index with each stock’s weight proportionate to its market value. The S&P Index is one of the most widely used benchmarks of U.S. equity performance. The performance of the S&P Index does not account for any management fees, incentive compensation, commissions or other expenses that would be incurred pursuing such strategy. Total return provides investors with a price-plus-gross cash dividend return. Gross cash dividends are applied on the ex-date of the dividend.

MSCI World Index: The MSCI World Index is a free float adjusted market capitalization weighted index that is designed to measure the global equity market performance of developed markets. The term “free float” represents the portion of shares outstanding that are deemed to be available for purchase in the public equity markets by investors. The performance of the Index is listed in U.S. dollars and assumes reinvestment of gross of dividends.

Hedge Fund Research, Inc. (HFRI) Event-Driven: Distressed/Restructuring Index. Distressed/Restructuring strategies which employ an investment process focused on corporate fixed income instruments, primarily on corporate credit instruments of companies trading at significant discounts to their value at issuance or obliged (par value) at maturity as a result of either formal bankruptcy proceeding or financial market perception of near term proceedings. Managers are typically actively involved with the management of these companies, frequently involved on creditors’ committees in negotiating the exchange of securities for alternative obligations, either swaps of debt, equity or hybrid securities. Managers employ fundamental credit processes focused on valuation and asset coverage of securities of distressed firms; in most cases portfolio exposures are concentrated in instruments which are publicly traded, in some cases actively and in others under reduced liquidity but in general for which a reasonable public market exists. In contrast to Special Situations, Distressed Strategies employ primarily debt (greater than 60%) but also may maintain related equity exposure.

Hedge Fund Research, Inc. (HFRI) Relative Value: Fixed Income Corporate Index. Fixed Income: Corporate includes strategies in which the investment thesis is predicated on realization of a spread between related instruments in which one or multiple components of the spread is a corporate fixed income instrument. Strategies employ an investment process designed to isolate attractive opportunities between a variety of fixed income instruments, typically realizing an attractive spread between multiple corporate bonds or between a corporate and risk-free government bond. Fixed Income: Corporate strategies differ from Event Driven: Credit Arbitrage in that the former more typically involve more general market hedges which may vary in the degree to which they limit fixed income market exposure, while the later typically involve arbitrage positions with little or no net credit market exposure, but are predicated on specific, anticipated idiosyncratic developments.

Hedge Fund Research, Inc. (HFRI) Equity Hedge: Equity Market Neutral Index. Equity Market Neutral strategies employ sophisticated quantitative techniques of analyzing price data to ascertain information about future price movement and relationships between securities, select securities for purchase and sale. These can include both Factor-based and Statistical Arbitrage/Trading strategies. Factor-based investment strategies include strategies in which the investment thesis is predicated on the systematic analysis of common relationships between securities. In many but not all cases, portfolios are constructed to be neutral to one or multiple variables, such as broader equity markets in dollar or beta terms, and leverage is frequently employed to enhance the return profile of the positions identified. Statistical Arbitrage/Trading strategies consist of strategies in which the investment thesis is predicated on exploiting pricing anomalies which may occur as a function of expected mean reversion inherent in security prices; high frequency techniques may be employed and trading strategies may also be employed on the basis of technical analysis or opportunistically to exploit new information the investment manager believes has not been fully, completely or accurately discounted into current security prices. Equity Market Neutral Strategies typically maintain characteristic net equity market exposure no greater than 10% long or short.

Hedge Fund Research, Inc. (HFRI) Emerging Markets (Total) Index. Emerging Markets funds invest, primarily long, in securities of companies or the sovereign debt of developing or “emerging” countries. Emerging Markets regions include Africa, Asia ex-Japan, Latin America, the Middle East and Russia/Eastern Europe. Emerging Markets - Global funds will shift their weightings among these regions according to market conditions and manager perspectives.

CRC 2335498 (12/2018) 

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