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- Herausgeber: John Wiley & Sons
- Kategorie: Fachliteratur
- Sprache: Englisch
- Veröffentlichungsjahr: 2013
New commentary and updates to enlightening interviews with today's top global macro hedge fund managers This updated paperback edition of Inside the House of Money lifts the veil on the typically opaque world of hedge funds offering a rare glimpse at how today's highest paid money managers approach their craft. Now with new commentary, author, Steve Drobny takes you even further into the hedge fund industry. He demystifies how these star traders make billions for their well-heeled investors, revealing their theories, strategies and approaches to markets. Whereas some still maintain that rationality permeates financial markets, Drobny captures a different dimension, showing how the unquantifiable human forces of emotion and intuition are also at play. Along the way, readers get an inside look at firsthand trading experiences through some of the major world financial crises of the last few decades. * Discusses how no market or instrument is out of bounds for these elite global macro hedge fund managers * Offers unique and illuminating insight into an inaccessible and sometimes downright secretive world * Written by respected industry expert Steven Drobny Highly accessible and filled with in-depth expert opinion, this updated paperback edition of Inside the House of Money is a must-read for financial professionals and anyone else interested in understanding how greed, fear, and the human forces of emotion drive world markets.
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Contents
Foreword
Preface
Preface to the 2009 Edition
Preface to the 2006 Edition
Chapter 1: Introduction to Global Macro Hedge Funds
Summary
Chapter 2: The History of Global Macro Hedge Funds
The Next Generation of Global Macro Managers
Major Global Macro Market Events
Global Macro is Dead
A Final Word on Soros
Chapter 3: The Future of Global Macro Hedge Funds
From Global Macro to Global Micro
Chapter 4: The Family Office Manager
The Family Office Manager, Part Two
Chapter 5: The Prop Trader
Chapter 6: The Treasurer
Chapter 7: The Central Banker
Chapter 8: The Dot-Commer
Chapter 9: The Floor Trader
Chapter 10: The Pioneer
Chapter 11: The Commodity Specialist
Chapter 12: The Stock Operator
Chapter 13: The Emerging Market Specialist
Chapter 14: The Fixed Income Specialists
Chapter 15: The Currency Specialist
Conclusion
Appendix: A Note to Investors about Global Macro
Acknowledgments
Bibliography
Index
Further Praise for Inside the House of Money from Hedge Fund Investors
“Drobny has done a great job of capturing the inner workings of macro trading by interviewing some of the most interesting people in the field today. This book is a treat and a must-read if you want to understand how the market’s best manage their portfolios.”
—Mark Taborsky, Vice President,
External Management
Harvard Management Company
“Inside the House of Money provides a unique insight into the hedge fund business. For those who think hedge funds are mysterious, here they will find them transparent. Readers will be fascinated to see that there are so many ways to make money from an idea.”
—Bernard Sabrier, Chairman, Unigestion
“With its behind-the-scenes perspective and macro focus, this book is an entertaining, educational read, and also fills a substantial gap in hedge fund literature.”
—Jim Berens, Cofounder and Managing Director,
Pacific Alternative Asset Management
Company (PAAMCO)
“An exciting, fast-paced insider’s look at the elite, often mysterious world of high finance. This book is the real deal. An absolute must-read for every endowment, foundation, or pension fund officer considering investing with hedge funds.”
—Michael Barry, Chief Investment Officer,
University of Maryland Endowment
Cover Design: Michael J. Freeland
Cover Photograph: © Getty Images
Copyright © 2006, 2009, 2014 by Steven Drobny. All rights reserved.
Published by John Wiley & Sons, Inc., Hoboken, New Jersey.
Published simultaneously in Canada.
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ISBN 978-1-118-84328-4 (paper); ISBN 978-1-118-86572-9 (ebk);
ISBN 978-1-118-86557-6 (ebk)
The social objective of skilled investment should be to defeat the dark forces of time and ignorance which envelop our future.
—John Maynard Keynes
Once we realize that imperfect understanding is the human condition, there is no shame in being wrong, only in failing to correct our mistakes.
—George Soros
The things you own end up owning you.
—Tyler Durden
Foreword
I first met Steven Drobny in Barcelona in 2004. He had invited me to give a keynote address at a global macro hedge fund conference he was organizing. At that time, I had only the haziest notion of what a global macro hedge fund was, but I accepted—not realizing that the keynote at such an event was essentially a form of entertainment. No doubt I gave some spiel about the impending demise of the American empire or the unsustainable nature of the U.S. current account deficit or the impending liquidity crisis that would be triggered by some geopolitical crisis or other. The other conference participants—nearly all managers of macro hedge funds—listened more or less politely, but made little secret of their skepticism when it came to questions afterward. Given that the next four years were going to witness one of the greatest financial upswings of all time, they had good reason to be dubious.
The real business of the conference was not my after-dinner speech, of course, but the peer-to-peer sessions conducted the next day. As I listened with growing fascination, a succession of hedge fund managers stood up and explained with great precision how inordinately large sums of money could be made out of complex transactions, the like of which I had never heard. What was a “swap”? A “steepener”? And what on earth was the “Swissie” everyone kept talking about?
Having spent almost the entirety of my professional career in universities—apart from a one-year fellowship at the Bank of England—I had for many years complacently assumed that academics were the smartest people on the planet. Not well paid, to be sure, but otherwise rewarded by the pleasures and pains of scholarship. Yet I had always worried about the gap between the grand theories I and my colleagues discussed in the groves of academe and the rough-and-tumble world of practice. For years I had called myself an economic historian, with pretensions to understanding the world of finance. After a day at the conference I realized that I understood next to nothing.
What most impressed me about the global macro managers was the way they proceeded from theoretical insights derived from conventional economics, to empirical research, to the conception of a particular transaction, to the execution of the transaction—to the result itself. Here was a discipline generally lacking in many fields of social science and the humanities. Within a year at the outside, and more commonly a month, it would be clear if the trade had worked. Money would have been made or lost.
So impressed was I by what I saw in Barcelona that I made a mental note to attend more such events and, if possible, to get a little closer to the business of hedge fund management. I could think of few better ways to learn about the relationship between economic theory and financial practice.
Steven Drobny’s book makes an invaluable contribution by documenting what has been a quite extraordinary financial revolution. The rise of hedge funds stands out as one of the decisive structural changes witnessed in financial markets over the past 15 or 20 years. Future historians will thank Drobny—not least because hedge fund managers like the ones featured in these pages are rarely the kind of people who write their own memoirs.
Although written in 2004–2006, long before the great subprime crisis begat the credit crunch and (perhaps) the recession of 2008–2009, Inside the House of Money repays rereading today. Many of the managers interviewed here anticipated the coming crisis, sensing that the explosion of leverage in the United States and the widening of the U.S. current account deficit were unsustainable trends. If anyone had an incentive to anticipate the great structural shifts of our time—not least the relative decline of the United States and the rise of East Asia and South Asia—it was the macro hedge funds.
With Western economies staring recession in the face, and many traditional financial institutions teetering on the brink not just of liquidity but of solvency, we are living through the most turbulent economic time in living memory. Volatility is back with a vengeance. The smartest of the Macro Funds saw this coming and were so well positioned that they actually made money from it. Anyone who wants to follow their example would benefit from the insights that Steven Drobny has gathered here.
Preface
When I first started writing this book in 2004, there was virtually no information on the topic of global macro as an investment strategy, save a few chapters here and there in well-dated books. After enough investor calls, meetings, and e-mails asking where to find information on global macro, I started to put pen to paper, and this book evolved quite organically out of those initial notes. I set out to define global macro as a strategy, but it became a real education and adventure for me, as I found myself charting a new course.
Fast-forward to today—nearly a decade later—and everyone is talking about global macro. Not only does every bank have a macro strategist, but they also have a China macro strategist, a Fixed Income macro strategist, an Emerging Markets macro strategist, and so on. A variety of global macro research newsletters, blogs, and touts have also been spawned, more often than not preaching doom and gloom. Even CNBC, which was formerly preoccupied with discussions about tech stocks or the Dow Jones Industrial Average, now regularly opines about the U.S. dollar, LIBOR, European interest rates, Greek equities, Chinese currency values, Hong Kong housing prices, commodity spreads, and credit default swaps.
Macro has gone mainstream, but global macro as an investment strategy is far more nuanced than just talking about macro instruments. And as more and more macro tourists enter the fray, it seems as if the art of global macro investing has been lost in the noise.
And the art of global macro is embedded in a manager’s investment and risk management processes. Almost every investment decision comprises an implicit macro bet. When a long/short equity manager shorts the Hong Kong dollar, he does not instantly become a global macro manager. When a global equity investor calls for yield curve steepening or a merger arbitrage manager buys credit default swaps on Germany, they should not be considered global macro managers.
Implementing global macro as a strategy is far more complex than putting on an occasional hedge or opportunistic trade. It is a difficult strategy to understand because, unlike, say, long/short equity, a manager can express trades in a myriad of different ways. The range of instruments and markets available to a global macro manager means that five different managers can have exactly the same view but generate five completely different profit-and-loss (P&L) streams, depending on how they express a trade. Likewise, a currency specialist and an equity specialist and a rates specialist might all be categorized as global macro hedge funds, yet each has a very different approach to the market and ultimate trade expression, given where and how they are most comfortable expressing risk. This breadth and complexity are what make macro so challenging.
Other hedge fund strategies are easier to understand, as they typically employ a much narrower range of instruments. Furthermore, most other strategies tend to have an embedded equity beta, which hurt them in 2008 but (if they survived) has provided a significant tailwind ever since. A long/short equity hedge fund is either long or short an individual stock, but is almost always net long. How this justifies a 2/20 fee structure is beyond me, but that discussion is for another day (or book).
In 2006, when this book was originally published, there was a significant amount of skepticism about the effectiveness of global macro as an investment strategy. Attention to deep out-of-the money tail risk events and rigorous risk management were for the faint of heart and nonbelievers. Suddenly, in 2008, when portfolios lost a third or more of their value, all investors started asking fundamental questions about how to more effectively manage risk and avoid large drawdowns.
As incorporating a global macro view became increasingly important, the classic macroeconomic textbooks became irrelevant as central banks around the world went unconventional and governments loosened up the rules by implementing unorthodox policies to address the global crisis. The powers that be broke the glass and threw out the rulebook.
As a result, there is no playbook for navigating today’s markets. For this reason, these dated interviews with global macro managers are even more relevant today than when they were first published. Policy has been dominating markets, whether in Japan, Europe, or Latin America. Understanding how different macro managers interpret global events, prioritize trading themes, express trades in their portfolios, and, most important, manage their risk under extreme scenarios is immensely important.
As I write, the S&P is above its all-time highs, Japan is reawakening from a 20-year slumber, U.S. interest rates have bounced off historical lows, and commodity markets across the board have seen pressure.
The world has changed. But it is always changing. Market practitioners always have to adapt to increasing complexity and new variables. Good risk management, however, is unchanging. One only has to reread Reminiscences of a Stock Operator, first published in 1923, to realize that nothing has changed. Sure, more advanced concepts can be incorporated into a portfolio, or a manager can employ more robust risk management systems, but the basic framework or approach to risk management is as simple today as it has always been. I believe chip stack management is the most important skill in money management, far more important than brains, information, or making the right call. And this is exactly where the best global macro managers excel.
In rereading this book now, I still learn new things, picking up on nuances that become more relevant today given the different macro environment. With hindsight, it is fascinating to read what managers were predicting back in 2004–2005. Although almost all of them called the crash, as one manager noted: if you are right but too early, you are wrong. Certain words or concerns or specific trades take on new meaning now that we know what happened. Rereading this book is like watching a scary movie once the creepy music starts—you know something bad is just around the corner.
Since this book came out, we have all been forced to take a crash course in crisis management. But only now, amidst the (relative) stability of the prevailing environment, can we more fully process the events of 2008, instead of scrambling and reacting in the moment. However, it is precisely when times are quiet that preparing for the next storm becomes paramount. Extreme scenario testing is the best thing that a money manager can practice.
It is also interesting to follow the careers of the managers interviewed in this book, now almost 10 years later. Some have closed their funds, while others have prospered. Peter Thiel, for example, has wound down his macro hedge fund to focus on his family office, having monetized his early-stage investment in Facebook (which is one of the greatest macro trades of all time—a distressed equity call option with no expiry). And Scott Bessent has returned to Soros Fund Management, one of the largest players in the macro space, as the chief investment officer.
More than anything, macro is a framework, a prism through which to see the world, filter ideas, and ultimately express and manage risk in your portfolio, whether that portfolio happens to be run in a hedge fund structure or not. And it cannot be ignored.
Steven Drobny
Malibu, California
August 2013
Preface to the 2009 Edition
The original version of this book came out in spring 2006, near the tail end of what has been called “the great moderation,” a period of low volatility, low interest rates, flat yield curves, and strong global equity and property markets that made investors relatively complacent about risk. Since then, we have seen a dramatic unwinding of this paradigm as extreme volatility has been ushered back into the markets. Large and divergent interest rate movements have become common, and equity and housing markets have in many instances fallen sharply from elevated levels. Central banks and governments around the world have responded with creative liquidity measures and bailouts, as well as monetary and fiscal stimuli. These actions have not come without costs. Commodity prices exploded and then sold off, further complicating the inflation outlook for policy makers.
Stability seems to have bred instability, as Hyman Minsky once observed. Leverage, built up during the low-volatility quiet period, finally unraveled under its own weight, helped by central banks that raised interest rates. Although many were left naked as the tide receded, particularly exposed is the web of complex derivatives (SIVs, CDOs, CLOs, etc.) and the financial creativity in the home lending arena, which created so much credit around the world. It is now clear that home prices do not always go up, much to the chagrin of rating agencies, governments, banks, investors, and leveraged homeowners globally.
Once the easy money dried up, a lot of the manager predictions in this book came to fruition. In particular, we have seen the U.S. dollar fall, commodities and oil rally to levels not seen since the 1970s, the housing boom turn into a bust, major equity markets around the world crash, credit spreads blow out, and volatility return from historically low levels.
Arguably, excess credit was the main driver of the low-volatility period from 2003 to 2007, whereas the tightening of credit has led to many sharp reversals in 2007 and 2008. As central banks again cut rates to bail out investors, the next leg of this cycle is upon us. But will this process lead to inflation, hyperinflation, stagflation, or is deflation unavoidable?
Likewise, will the world turn Keynesian with continued government stimulus or take the pain the Austrian way? The adage that there is always a bull market somewhere might very well speak to an imminent increase in government intervention, regulation, and legal bills. Will the trend toward globalization be altered in the process and what will the investment implications be as a result?
Other important questions face investors: Will the emerging world decouple from the developed world? Can China, India, Brazil, Russia, and others continue their dramatic growth without the help of their biggest customers? Is the United States in for a Japan-style lost decade, a European-style muddle through, or another Great Depression?
It became clear in 2008 that macro variables have emerged as the predominant drivers of investment performance. Bottom up/micro focused equity, bond, and commodity investors have been decimated, while global macro managers, for the most part, have been able to preserve investor capital. As such, global macro portfolio managers are exceptionally well-positioned to navigate what could be a sustained period of choppy, volatile markets. The managers in this book offer a snapshot of a diverse selection of global macro substrategies. Enhanced knowledge of each should serve investors well while trying to stay afloat in these increasingly uncertain times.
For the paperback version, I have added a “Part Two” to the chapter with Jim Leitner. I have also added an addendum to Peter Thiel’s chapter.
Steven Drobny
Manhattan Beach, California
June 2008
Preface to the 2006 Edition
Hedge funds are everywhere today. The term hedge fund used to conjure images of speculators hunting for absolute returns in any market in the world, using any instrument or style to capture their prey. The managers of the original multibillion-dollar mega-funds, such as George Soros or Julian Robertson, became well-known figures because of their speculative prowess. Yet they were also accused of such modern ills as attacks on developed world central banks and capital flight in the third world.
After the stock market crash of 2000, hedge funds came into their own by proving to be a superior asset management vehicle. As most global investors were suffering year after year of negative returns, hedge funds performed. This encouraged a wave of institutional money to flow into such alternative investment vehicles. At the same time, given the superior flexibility and attractive compensation structure of hedge funds, the most talented financial minds migrated over in what became a mass exodus from The City and Wall Street.
As hedge funds have matured, they have become more of a business. The tremendous inflow of capital has altered the freewheeling image of more than a decade ago. This shift has spawned a more formalized industry where managers often implement rather narrow, specific strategies and where investors in hedge funds no longer tolerate down years or even down months of performance. Competition has smoothed returns, both on the upside and the downside, and lower returns have led to questions about hedge fund fees.
Amidst this evolution and change in the hedge fund business, one strategy has remained true to its original mandate of absolute return investing, seeking outsized returns from investments anywhere in the world, in any asset class and in any instrument: global macro.
Global macro investing is still a relatively unknown and misunderstood area of money management but increasingly of interest. Given that my firm, Drobny Global Asset Management, advises investors on global macro hedge funds I am often asked the question, “What is global macro?”
The classic definition—a discretionary investment style that leverages long and short positions in any asset class (equities, fixed income, currencies, and commodities), in any instrument (cash or derivatives), in any market around the world with the goal of profiting from macroeconomic trends—often fails to satisfy. What I think people are really asking is, “How does one define what the top global macro money managers actually do?”
That’s a trickier question. Global macro is the most difficult of the hedge fund strategies to define, simply because there is no definition. Just as the term hedge fund can be used to describe a wide variety of investing styles, so too global macro does not mean just one thing. Global macro has no mandate, is not easily broken down into numbers or formulas, and style drift is built into the strategy as managers often move in and out of various investing disciplines depending on market conditions. Even professional hedge fund investors struggle at times to decipher what global macro managers actually do.
To help my inquisitors, I searched for books and research papers on the topic to recommend but found very little of value. This is surprising given the tremendous growth of assets and sophistication in the hedge fund business over the past few years and the fact that the public still associate hedge funds with the doyen of global macro, George Soros.
Another reason the lack of literature on global macro is odd is that global macro variables influence all investment strategies. When a mutual fund increases its cash position, an endowment allocates to real estate, or an equity long/short hedge fund goes net long stocks, they are all making implicit global macro calls—even if they are not aware of it. Their investment decisions are subject to changes in the world economy, the U.S. dollar, global equities, global interest rates, global growth, geopolitical issues, energy prices, and a multitude of variables of which they may never have heard. As such, an understanding of the global macro picture would seem of the utmost importance to the wider investment community.
This book attempts to fill the gap in the literature. With the dearth of quality information out there about global macro, the next logical step was to speak directly to the smartest global macro managers I knew. With the benefit of the access afforded through my business, I was able to draw on a host of resources to do just that.
The original plan for these discussions with practitioners was simply to discover what global macro means to them, but the conversations proved to be much deeper. I learned how the best minds in the business think about risk, portfolio construction, history, politics, central bankers, globalization, trading, competition, investors, hiring, the evolution of the hedge fund business, and a variety of other details. As a result, a more involved research project developed.
After these initial discussions, I set out to speak with a broader selection of today’s top global macro hedge fund managers. In search of the widest possible variety of views, I interviewed managers who have different product specialties, diverse backgrounds, and varied mandates. I chose to focus on fundamental discretionary managers rather than those who depend solely on technical patterns or computer-driven trading models, because fundamental discretionary managers rely on their own judgment above and beyond any analytical tools they may employ.
As it turns out, there is no simple way to define what the top global macro managers actually do. Rather, global macro is an approach to markets in the way that science is an approach to the unknown. As in science, many different approaches can be used to tackle a question and, while many fail, several wildly different paths can lead to success. It is in the course of the development and testing of market hypotheses where the art or the genius lies.
Although global macro funds tend to be idiosyncratic, I found that all global macro managers begin with a broad top-down approach to the world before drilling down into the fine details. It is in the process of drilling down where they differentiate themselves, ending in a wide variety of specialties. In a sense, global macro is evolving into global micro, whereby today’s managers derive their investment edge through having the latitude to express their micro expertise in various specialties and markets.
I found other similarities among the managers in that they all love what they do, are incredibly hardworking, and are extremely smart. Yet despite their intelligence and strong opinions, they all seemed open-minded and flexible when it came to being challenged by the market or their colleagues. This flexibility and willingness to admit that they could be wrong is, in a sense, how good hedge fund managers limit their downside risk and cut off the left side of the return distribution. When it comes down to it, no matter the specific style of the manager, the goal of all global macro hedge fund managers is to produce superior risk-adjusted absolute returns for their investors and themselves.
In the end, this book does not answer the question, “What is global macro?” Instead, it offers an inside look at how some of today’s best and the brightest practitioners think about their area of expertise. Hopefully, this book will simultaneously help to demystify what today’s global macro managers actually do and show why there are so few who truly excel in this endeavor. If you learn as much from reading these interviews as I did conducting them, I will consider this research project a success.
I begin with a word from Joseph G. Nicholas, founder and chairman of HFR Group, who offers a professional investor’s perspective of global macro. Next, I briefly highlight some of the key historical events in global macro to offer background and perspective which should prove helpful while reading the interviews. I attempt to show the evolution of global macro from its origins with John Maynard Keynes to George Soros, and then on to the future where increased competition and specialization are leading today’s global macro manager into the realm of global micro.
Finally, we go “inside the house of money” via a collection of 12 interviews with top global macro practitioners, each of whom offers a unique perspective on global markets. The interviews were conducted all over the world between October 2004 and July 2005.
Steven Drobny
Manhattan Beach, California
January 2006
Chapter 1
Introduction to Global Macro Hedge Funds
Joseph G. Nicholas
Founder and Chairman of HFR Group
The global macro approach to investing attempts to generate outsized positive returns by making leveraged bets on price movements in equity, currency, interest rate, and commodity markets. The macro part of the name derives from managers’ attempts to use macroeconomic principles to identify dislocations in asset prices, while the global part suggests that such dislocations are sought anywhere in the world.
The global macro hedge fund strategy has the widest mandate of all hedge fund strategies whereby managers have the ability to take positions in any market or instrument. Managers usually look to take positions that have limited downside risk and potentially large rewards, opting for either a concentrated risk-taking approach or a more diversified portfolio style of money management.
Global macro trades are classified as either outright directional, where a manager bets on discrete price movements, such as long U.S. dollar index or short Japanese bonds, or relative value, where two similar assets are paired on the long and short sides to exploit a perceived relative mispricing, such as long emerging European equities versus short U.S. equities, or long 29-year German Bunds versus short 30-year German Bunds. A macro trader’s approach to finding profitable trades is classified as either discretionary, meaning managers’ subjective opinions of market conditions lead them to the trade, or systematic, meaning a quantitative or rule-based approach is taken. Profits are derived from correctly anticipating price trends and capturing spread moves.
Generally, macro traders look for unusual price fluctuations that can be referred to as far-from-equilibrium conditions. If prices are believed to fall on a bell curve, it is only when prices move more than one standard deviation away from the mean that macro traders deem that market to present an opportunity. This usually happens when market participants’ perceptions differ widely from the actual state of underlying economic fundamentals, at which point a persistent price trend or spread move can develop. By correctly identifying when and where the market has swung furthest from equilibrium, a macro trader can profit by investing in that situation and then getting out once the imbalance has been corrected. Traditionally, timing is everything for macro traders. Because macro traders can produce significantly large gains or losses due to their use of leverage, they are often portrayed in the media as pure speculators.
Many macro traders would argue that global macroeconomic issues and variables influence all investing strategies. In that sense, macro traders can utilize their wide mandate to their advantage by moving from market to market and opportunity to opportunity in order to generate the outsized returns expected from their investor base. Some global macro managers believe that profits can and should be derived from other, seemingly unrelated investment approaches such as equity long/short, investing in distressed securities, and various arbitrage strategies. Macro traders recognize that other investment styles can be profitable in some macro environments but not others. While many specialist strategies present liquidity issues for other, more limited investing styles in charge of substantial assets, macro managers can take advantage of these occasional opportunities by seamlessly moving capital into a variety of different investment styles when warranted. The famous global macro manager George Soros once said, “I don’t play the game by a particular set of rules; I look for changes in the rules of the game.”
SUMMARY
Global macro traders are not limited to particular markets or products but are instead free of certain constraints that limit other hedge fund strategies. This allows for efficient allocation of risk capital globally to opportunities where the risk versus reward trade-off is particularly compelling. Whereas significant assets under management can prove an issue for some more focused investing styles, it is not a particular hindrance to global macro hedge funds given their flexibility and the depth and liquidity in the markets they trade. Although macro traders are often considered risky speculators due to the large swings in gains and losses that can occur from their leveraged directional bets, when viewed as a group, global macro hedge fund managers have produced superior risk-adjusted returns over time.
From January 1990 to December 2005, global macro hedge funds have posted an average annualized return of 15.62 percent, with an annualized standard deviation of 8.25 percent. Macro funds returned over 500 basis points more than the return generated by the S&P 500 index for the same period with more than 600 basis points less volatility. Global macro hedge funds also exhibit a low correlation to the general equity market. Since 1990, macro funds have returned a positive performance in 15 out of 16 years, with only 1994 posting a loss of 4.31 percent. (See Figure 1.1.)
Figure 1.1 Comparison of HFRI Macro Index with S&P 500
Source: HFR.
In light of the correlation, volatility, and return characteristics, global macro hedge fund strategies are a welcome addition to any portfolio.
Chapter 2
The History of Global Macro Hedge Funds
The path to today’s style of global macro investing was paved by John Maynard Keynes a century ago. For an economist, Keynes was a renaissance man. Not only was he the father of modern macroeconomic theory but he also advised world governments, was involved in the Bloomsbury intellectual circle, and helped design the architecture of today’s global macroeconomic infrastructure by way of the World Bank and International Monetary Fund. At the same time, he was also a successful investor, using his own macroeconomic principles as an edge to extract profit from the markets. Some say he was the first of the modern global macro money managers.
In the words of Keynes’ biographer Robert Skidelsky, “[Keynes] was an economist; he was an investor; he was a patron of the arts and a lover of ballet. He was a speculator. He was also confidant of prime ministers. He had a civil service career. So he lived a very full life in all those ways.”
Keynes speculated with his personal account, invested on behalf of various investment and insurance trusts and even ran a college endowment, each of which had different goals, time horizons, and product mandates. Upon his death, he left a substantial personal fortune primarily a result of his financial market activities.
Evidence of Keynes’ investing acumen can be found in the returns of the King’s College Cambridge endowment, the College Chest, for which he had total discretion as the First Bursar. A publicly available track record shows he returned an average of 13.2 percent per annum from 1928 to 1945, a time when the broad UK equity index lost an average of 0.5 percent per annum. (See Figure 2.1.) This was quite a feat considering the 1929 stock market crash, the Great Depression, and World War II occurred over that time frame.
Figure 2.1 King’s College Cambridge Chest Fund and the UK Broad Country Equity Index
Source: Motley Fool.
But, like all great investors, Keynes first had to learn some difficult lessons. He was not immune to blowups in spite of his superior intellect and understanding of global markets. In the early 1900s, he successfully speculated in global currencies on margin before switching to the commodity markets. Then, during the commodity slump of 1929, his personal account was completely wiped out by a margin call. After the 1929 setback, his greatest successes came from investing globally in equities but he continued to speculate in bonds and commodities.
Skidelsky adds, “His investment philosophy. . .changed in line with his evolving economic theories. He learned a lot of his theory from his experience as an investor and this theory in turn modified his practice as an investor.”
Keynes’ distaste of floating currencies (ironically his original vehicle of choice for speculating) eventually led him to participate in the construction of a global fixed currency regime at Bretton Woods in 1945. The post-World War II economic landscape, coupled with the ensuing Cold War–induced peace and the relative stability fostered by Bretton Woods, led to a boom in developed-country equity markets starting in 1945 and lasting until the early 1970s. During that time, there were few better opportunities in the global markets than buying and holding stocks. It wasn’t until the breakdown of the Bretton Woods Agreement in 1971, and the subsequent decline in the U.S. dollar, that the investment universe again offered the opportunities that spawned the next generation of global macro managers.
THE NEXT GENERATION OF GLOBAL MACRO MANAGERS
The next round of global macro managers emerged out of the breakdown of the Bretton Woods fixed currency regime, which untethered the world’s markets. With currencies freely floating, a new dimension was added to the investment decision landscape. Exchange rate volatility was introduced while new tradable products were rapidly being developed. Prior to the breakdown of Bretton Woods, most active trading was done in the liquid equity and physical commodity markets. As such, two different streams of global macro hedge fund managers emerged out of these two worlds in parallel.
The Equity Stream
One stream of global macro hedge fund managers emerged out of the international equity trading and investing world.
Until 1971, the existing hedge funds were primarily focused on equities and modeled after the very first hedge fund started by Alfred Winslow Jones in 1949. Jones’s original structure is roughly the same as most hedge funds today: It was domiciled offshore, largely unregulated, had less than 100 investors, was capitalized with a significant amount of the manager’s money, and charged a performance fee of 20 percent. (Allegedly, the now standard 20 percent performance fee was modeled by Jones upon the example of another class of traders who demanded a profit sharing arrangement that provided the proper incentive for taking risk: Fifteenth-century Venetian merchants would receive 20 percent of the profits from their patrons upon returning from a successful voyage.)
The A.W. Jones & Co. trading strategy was designed to mitigate global macro influences on his stock picking. Jones would run an equally weighted “hedged” book of longs and shorts in an attempt to eliminate the effects of movements by the broader market (i.e., stock market beta). Once currencies became freely floating, though, a new element of risk was added to the equation for international equities. Whereas managers using the Jones model sought to neutralize global macro–induced moves, the global macro managers who emerged from the international equity arena sought to take advantage of these new opportunities. Foreign exchange risk was treated as a whole new tradable asset class, especially in the context of foreign equities where currency exposure became a major factor in performance attribution.
Managers from this stream such as George Soros, Jim Rogers, Michael Steinhardt, and eventually Julian Robertson (Tiger Management) were all too willing to use currency movements as an additional opportunity set to be capitalized upon. They were already successful global long/short equity investors whose experience in global markets made the shift to currencies and foreign bonds seamless in the post–Bretton Woods world. In the early days of this new paradigm, these managers saw little in the way of competition. Over time, though, as their superior returns attracted larger amounts of capital, the funds were increasingly forced to trade deeper, more liquid markets and thus move beyond their core competence of stock picking. At the same time, competition intensified.
The Commodity Stream
The other stream of global macro managers developed out of the physical commodity and futures trading world that was centered in the trading pits of Chicago. It developed independently although simultaneously with the equity stream.
The biggest global macro names to emerge from the commodity world, however, did not come from the Chicago epicenter but instead learned their craft from the most forward thinking of commodity and futures trading firms: Commodities Corporation of Princeton, New Jersey.
The founder of Commodities Corporation (CC), Helmut Weymar, is said by many to be the father of the commodity stream of global macro. Weymar, an M.I.T. PhD and former star cocoa trader for Nabisco, founded CC along with his mentor and legendary trader Amos Hostetter, wheat speculator Frank Vannerson, and his former professor, Nobel Prize winner Paul Samuelson, with the goal of providing an ideal environment where traders could take risk without worrying about administration and other distractions. The management of CC had a solid understanding of risk taking and offered an incredibly open framework in which traders thrived. CC incubated or served as an important early source of funding for some of the best known global macro managers of all time, including Bruce Kovner (Caxton), Paul Tudor Jones (Tudor Investment Corporation), Louis Bacon (Moore Capital), Michael Marcus, Grenville Craig, Ed Seykota, Glen Olink, Morry Markowitz, and Willem Kooyker (Blenheim Capital), to name a few.
Commodities Corporation was originally set up to take advantage of tradable physical commodities, and traders were siloed such that each focused exclusively on one commodity market. As world trade opened up in the 1970s and 1980s, global macroeconomic influences started to play a larger and more important role in determining the price movements in the commodity markets. Being accustomed to the sometimes extreme volatility, and having the knowledge of the macroeconomic influences on their specific markets, the firm easily moved into trading currency and financial futures as those markets developed. For CC traders, as long as there was volatility, they were indifferent to the underlying asset.
Commodities Corporation traders involved in all products became known as “generalists.” While CC founder Hostetter had been trading stocks, bonds, and commodities since the 1930s, the first successful generalists to emerge at CC were plywood and cotton trader Michael Marcus and his young assistant Bruce Kovner. Kovner especially pushed CC toward a more global macro style of trading, which meant trading all products, anytime, anywhere. He also started another trend in the organization, namely, leaving the firm to set up his own fund. Started with the blessing and initial capital from CC, Kovner’s fund, Caxton, is now one of the largest hedge fund management groups in the world as measured by assets under management. Likewise, several other CC alumni are managing some of the largest hedge fund complexes today. Many credit their success to lessons learned at CC about risk management, leverage, and trading. As a testament to its success, Commodities Corporation was purchased by Goldman Sachs in 1997 after evolving into more of a fund of hedge funds investment vehicle, with many allocations still out to original CC traders.
MAJOR GLOBAL MACRO MARKET EVENTS
For the purposes of this book, we are going to use the experiences of the global macro pioneers, such as Soros, Robertson, and Tudor Jones to discuss some of the important episodes in the global macro arena over the past few decades, mainly because macro markets were dominated by these managers until 2000.
What is interesting about these episodic moments in global macro history is not what happened to the macro trading community, but rather that the lessons learned from these events served as the education for today’s generation of global macro managers.
Today’s managers, many of whom are alumni of the original global macro fund managers, earned their stripes during the ensuing crises and events. While Keynes had his 1929 event to learn about the positive and negative effects of trading on leverage, which he subsequently incorporated into his trading style and translated into future success, today’s managers had the 1987 stock market crash, the sterling crisis of 1992, the bond market rout of 1994, the Asia crisis of 1997, the Russia/LTCM crisis of 1998, and finally the dot-com bust of 2000. (See Figure 2.2.) The ways that today’s managers look at markets, control risk, and manage their businesses include lessons learned through these important events.
Figure 2.2 Major Global Macro Market Events since 1971
Source: DGA.
The Stock Market Crash of 1987
Although the U.S. stock market crash of October 1987 is now a mere blip on long-term stock market charts (see Figure 2.3), as indexes fully recovered only two years later, the intensity of Black Monday for traders who lived through it has certainly left its mark. Most notably, the notions of liquidity risk and fat tails were introduced to the wider investment community without mercy. Entire portfolios and money management businesses were obliterated on that day as margin calls went unfunded. Indeed, even so-called “portfolio insurance” hedges didn’t work as the futures and options markets became unhinged from the cash market.
Figure 2.3 S&P 500 Index, 1980–2005
Source: Bloomberg.
Yra Harris (Praxis Trading) explains in his interview later in this book what he saw that day on the floor of the Chicago Mercantile Exchange:
It was eerie and scary because you just didn’t know the extent of everything. People were clearly hurting badly but you just didn’t know how badly. I’ve traded through a lot of devaluations and debacles but I’ve never seen as many people pulled off the floor by clearinghouses as I did that day. The pit was practically empty, which actually turned into a great opportunity to trade the S&Ps. I went into the S&P pit and starting making markets because nobody else was. Spreads were so unbelievably wide that it was pretty easy to make money just scalping around. Honestly, I couldn’t help it.
Global macro managers from the equity stream, including George Soros, got hurt in the 1987 crash. Just prior to the crash, Fortune magazine ran a cover story entitled, “Are Stocks Too High?” in which Soros disagreed with the notion. Days later, Soros lost $300 million as stocks collapsed (yet Soros Fund Management still ended the year up 14 percent). Meanwhile, Tiger Management posted its first down year (−1.4 percent) only one year after an Institutional Investor article, noting Tiger’s 43 percent average annual returns since inception in 1980, sparked the next wave of hedge fund launches.
For global macro traders from the commodities stream, however, the 1987 crash served as a windfall event. Paul Tudor Jones in particular was elevated to star status when he famously caught the short side of the stock market and the long side of the bond market by identifying similarities between technical trading patterns in 1987 and the great crash of 1929. (See Figure 2.4.) Jones’s Tudor Investment Corporation returned 62 percent for the month in October 1987 and 200 percent for the year.
Figure 2.4 Dow Jones Industrial Average: The Late 1920s versus the Late 1980s
Source: Bloomberg.
The year 1987 also marked the introduction of a new Federal Reserve chairman in Alan Greenspan. Greenspan came into office in August 1987 and his first act a few weeks later was to raise the discount rate by 50 basis points. This unexpected tightening created volatility and uncertainty in the markets as traders adjusted to the style of a new Fed chairman. Some argue that Greenspan’s rate hike was actually the cause of the subsequent equity market meltdown a month-and-a-half later. Immediately after the stock market crash, Greenspan flooded the market with liquidity, initiating a process that came to be known as the “Greenspan put.” The Greenspan put is an implicit option that the Fed writes anytime equity markets stumble, in hopes of bailing out investors.
Former Federal Reserve chairman William McChesney Martin famously observed that the job of a central banker is to “take away the punch bowl just when the party is getting started.” Alan Greenspan, on the other hand, seemed to interpret his role as needing to intervene only as the partygoers are stumbling home. As he has claimed, bubbles can only be clearly observed in hindsight, such that the role of a central banker is to soften the impact of the bubble’s bursting rather than to take away the fuel for the party.
Black Wednesday 1992
The term global macro first entered the general public’s vocabulary on Black Wednesday, or September 16, 1992. Black Wednesday, as the sterling crisis is called, was the day the British government was forced to withdraw the pound sterling from the European Exchange Rate Mechanism (ERM)—a mere two years after joining—sending the currency into a free fall. The popular press credited global macro hedge fund manager George Soros with forcing the pound out of the ERM. As Scott Bessent (Bessent Capital), head of the London office of Soros Fund Management at the time, noted, “Interestingly, no one had ever heard of George Soros before this. I remember going to play tennis with him at his London house on the Saturday after it happened. It was as if he were a rock star with cameramen and paparazzi waiting out front.”
The ERM was introduced in 1979 with the goals of reducing exchange rate variability and achieving monetary stability within Europe in preparation for the Economic and Monetary Union (EMU) and ultimately the introduction of a single currency, the euro, which culminated in 1999. The process was seen as politically driven, attempting to tie Germany’s fate to the rest of Europe and economically anchor the rest of Europe to the Bundesbank’s successful low interest rate, low inflation policies.
The United Kingdom tardily joined the ERM in 1990 at a central parity rate of 2.95 deutsche marks to the pound, which many believed to be too strong. To comply with ERM rules, the UK government was required to keep the pound in a trading band within 6 percent of the parity rate. An arguably artificially strong currency in the United Kingdom soon led the country into a recession. Meanwhile, Germany was suffering inflationary effects from the integration of East and West Germany, which led to high interest rates. Despite a recession, the United Kingdom was forced to keep interest rates artificially high, in line with German rates, in order to maintain the currency regime. In September 1992, as the sterling/mark exchange rate approached the lower end of the trading band, traders increasingly sold pounds against deutsche marks, forcing the Bank of England to intervene and buy an unlimited amount of pounds in accordance with ERM rules. Fears of a larger currency devaluation sent British companies scrambling to hedge their currency exposure by selling pounds, further compounding pressures on the system.
In an effort to discourage speculation, UK Chancellor Norman Lamont raised interest rates from 10 percent to 12 percent, making the pound more expensive to borrow and more attractive to lend. However, this action only served to embolden traders and further frighten hedgers, all of whom continued selling pounds. Official threats to raise rates to 15 percent fell on deaf ears. Traders knew that continually raising interest rates to defend a currency during a recession is an unsustainable policy. Finally, on the evening of September 16, 1992, Great Britain humbly announced that it would no longer defend the trading band and withdrew the pound from the ERM system. The pound fell approximately 15 percent against the deutsche mark over the next few weeks, providing a windfall for speculators and a loss to the UK Treasury (i.e., British taxpayers) estimated to be in excess of £3 billion. (See Figure 2.5.)
Figure 2.5 Sterling/Mark and UK Base Rates, 1992
Source: Bloomberg.
It was reported at the time that Soros Fund Management made between $1 billion and $2 billion by shorting the pound, earning George Soros the moniker “the man who broke the Bank of England.” But he was certainly not alone in betting against the pound. While he may have borne a disproportionate amount of the criticism because of his significant gains, the government’s own policies are believed by many to have been the root cause of the problem, the speculators merely a symptomatic presence.
The pound eventually traded as low as 2.16 deutsche marks in 1995 but then rose as high as 3.44 in 2000 as the British economy recovered from recession and Germany suffered from the negative effects of euro integration. (See Figure 2.6.) Some credit today’s strength in the British economy with the interest rate and currency flexibility afforded by its position outside of the euro system. This is especially striking when the United Kingdom’s economic growth over the last decade is compared to the growth rates of formerly strong euro area countries such as Germany and France.
Figure 2.6 Sterling/Mark, 1990–2005
Source: Bloomberg.
Yra Harris amusingly claims in his interview that Great Britain should erect a statue of George Soros in Trafalgar Square as an expression of gratitude for taking the pound out of the ERM. Bessent adds, “A lot of credit should go to the UK officials. . .they knew to fold their hand quickly. UK Chancellor Norman Lamont and Prime Minister John Major suffered short-term humiliation for long-term good. I mean, look at the muddle France and Germany are still in.”
Following the sterling crisis, the next systemic event for the global macro community was the bond market rout of 1994, but this time, the outcome was not profitable.
Bond Market Rout of 1994
As the euro project gathered political steam throughout the late 1980s and early 1990s, convergence trades—trades profiting from the convergence of various currencies and bonds toward a single currency and interest rate—became the dominant theme in European foreign exchange and fixed income markets. The early 1990s especially witnessed several strong years in the European fixed income and currency markets. Global macro traders at banks and hedge funds jumped on the trend along with relative value traders and trend followers, who were all heavily long European bonds. Leveraged positions were predominantly taken in the bonds and currencies of the weaker, high interest rate eurozone countries which, after the United Kingdom opted out of the ERM, were Italy and Spain.
Then, in February 1994, Fed Chairman Greenspan surprised the markets by raising overnight U.S. interest rates from 3 percent to 3.25 percent, beginning a series of hikes that served to abruptly end the early 1990s’ period of easy money. Given the sizeable leveraged positions that had built up in the falling interest rate environment pre-1994, especially in the budding derivatives market, this unforeseen reversal of trend led to a generalized market sell-off. The 10-year U.S. government bond yield moved from 5.87 percent to 7.11 percent three months after the first hike, and most other markets also suffered trend reversals and declines. Likewise, the European bond trade that had worked so well until this point began to unravel. The sell-off was further compounded as margins were called, leveraged positions unwound, and continued price declines created a vicious cycle of forced selling. (See Figure 2.7.)
Figure 2.7 Yields: U.S. 10-Year Treasury, UK 10-Year Gilt, and German 10-Year Bund, 1993–1994
Source: Bloomberg.
Corporations on the receiving end of Wall Street’s derivative prowess, such as Procter & Gamble and Gibson Greetings, suffered major losses as their hedges went against them; Orange County, California, the wealthiest county in the United States at the time, declared bankruptcy as interest rate derivative structures imploded; and several well-known global macro funds either closed or went into hiding. Indeed, 1994 was the only down year for the HFR global macro index, which lost 4.3 percent (see Chapter 1).
Asia Crisis 1997
For most of the 1990s many Southeast Asian countries had currency regimes that were linked to the U.S. dollar (USD) through trading bands that were set and managed by the local central banks. For the first half of the 1990s the USD was falling, improving the competitiveness of the Southeast Asian countries. Then, in 1995, the USD started to appreciate on a trade-weighted basis and especially against the yen, where it appreciated by more than 50 percent from April 1995 to January 1997. Due to their link to the USD, the Southeast Asian currencies appreciated in kind, slowly eroding their competitive advantage. (See Figure 2.8.)
Figure 2.8 Japanese Yen, 1990–1998
Source: Bloomberg.
The USD link allowed local Southeast Asian borrowers to access cheaper funds offshore as U.S. interest rates were below local rates and their currencies were essentially pegged. They also borrowed a lot from Japan where interest rates were less than 1 percent and, post-1995, the Japanese clearly had a policy to weaken their currency. Given their confidence in the stable currency regime, Southeast Asians deemed such cross-currency borrowing as largely riskless. But expanding current account deficits, along with a rising competitive environment, most notably from China, and a strengthening USD, created pressures in the managed exchange rate system. Towards the middle of 1997, the Japanese banks were forced to increase their asset bases and were thus less inclined to roll over short-term debts. This drying up of liquidity for the Southeast Asian borrowers, coupled with a sudden rally in the yen in May 1997, brought to light some of the strains in the system.
As the risks became increasingly apparent, locals began to hedge their foreign exchange exposure, which meant heavy selling of local Southeast Asian currencies. As pressures on the system built, it became more difficult and more expensive for the local central banks to defend their currency regimes when their exchange rates approached the lower ends of the trading bands.
By July 1997, the Central Bank of Thailand saw its foreign currency reserve position dwindle in a futile effort to defend their currency regime and was left with little choice but to abandon the trading band. Without central bank support, the Thai baht immediately fell by 23 percent against the USD. (See Figure 2.9.) Lenders to Southeast Asian countries panicked en masse, withdrawing capital from the region or hedging their currency risk, which further depressed the Asian currencies. At the same time, locals borrowing in U.S. dollars and yen but getting paid in local currency rushed to hedge their worsening foreign exchange position. This led to a systemic sell-off across all Southeast Asian currencies, stock markets, and other assets linked to the former “Asian Tigers,” creating a contagion-like effect. Foreign investors rushed to pull their capital from the region without regard to specific country situations. The Thai baht eventually lost more than 50 percent of its value with other Southeast Asian currencies and stock markets sharing a similar fate. It was like a classic run on the bank, but in this case it was small economies and an entire region.
Figure 2.9 Thai Baht, 1997
Source: Bloomberg.
Many economists and institutions at the time blamed the Asia crisis on the openness of the global capital markets and the herd mentality of speculators. Malaysia’s prime minister, Dr. Mahathir Mohamad, publicly blamed George Soros for the economic ills that Malaysia suffered following the crisis and even considered currency speculation a crime. He shut down his country’s economy to so-called hot money by instituting draconian capital controls and fixing the Malaysian ringgit to the USD at 3.80. (See Figure 2.10.) As Scott Bessent recalls, it “was slightly worrying [because] it was the first time that someone had actually stopped paying lip service and actually shut down an economic system.”
Figure 2.10 Malaysian Ringgit, 1997–1998
Source: Bloomberg.
