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No hedge fund strategy will make money all of the time. As the market and economic environment changes, the performance of different strategies will also change. Hedge fund factor exposures will be different based on the strategy employed by the manager. If you cannot predict the environment factor exposures, there is value with holding a diversified portfolio of hedge funds. April performance clearly shows the difference in strategy behavior.

The SocGen CTA index was essentially flat for the month which is not surprising given three major factors. One, we are in a global risk-on environment which generally is not attractive for trend-followers. It is not that there are no trends, but there were limited gains from diversification across asset classes relative to a risk-on portfolio. Two, there were few strong trends going into the beginning of the month. Given the usual time-frame for effective trend-following which is weeks not days, there has to be continuity of trends to have a good performance month. The strong gains in foreign markets may not have been given enough exposure to generate good portfolio returns. Three, the focus on financials especially fixed income and currencies by large managers was a drag on performance relative to equities and short commodities trends. Four, volatility is at extreme lows. We have looked at market volatility through the VIX index and current levels are above the 98th percentile for the lowest since 1990. Divergent strategies based on taking advantage of the spread in prices through time will be limited in their return potential in this type of environment.

I was reviewing an interesting research piece from Covenant Capital on kurtosis across different assets traded in the futures markets. They offer a spreadsheet tool that can allow anyone to find the number of fat-tailed occurrences relative to a normal distribution. The data show that there are fat-tails everywhere across all asset classes. We do […]

It is a risk-on world with global equities (EFA) and emerging markets (EEM) now posting double digit gains for the year. A first round French election that was pointed less in the direction of Le Pen and a Trump presidency that does not seem as extreme as some pundits suggested has been coupled with global economic growth that is stronger than expected. The deflation trade may be further tempered in the US, but the threat of trade wars has diminished and the world economy is more focused on reality than dire economic scenarios.

There are many narratives for why equities or bonds will move higher, but a recurring theme is the financial conditions faced by investors. Financial conditions provide the tailwinds or headwinds to push asset class returns. These conditions tell us something about whether we will be transitioning between a risk-on and risk-off environment or whether we will be a crisis mode.

How do you know whether a model is broken? Or, how do you conduct a model review? There are many specific steps for any review but there are four major questions that have to be addressed that are separate from risk management. The key question of model efficacy should focus on forecasting skill and action. Does the model forecast correctly and is the model employed properly to make good decisions.

Globalization is a critical part of macro investing. There can be talk of separation politics, but for investors, you have to focus on the global economic cycle because the world is highly integrated. What is very interesting is that globalization has been fairly stable between the current environment and the Bretton Woods period as discussed by the recent work of Eric Monnet and Damien Puy who studied long horizon data available from the IMF. They find that there were two common shock periods which caused a highly synchronous global behavior. The first was oil shock period of the 70’s and the second was the Great Financial Crisis. You could say that these were the two periods when “correlations went to one” across asset classes. There was no international diversification benefit.

A growing stream of thinking in microeconomics is the concept of “winner-take-all” dynamics. The idea seems simple. A combination of networking economics and classic economies of scale creates situations where there are just a few dominant firms or economic agents who are able to capture significant market share in a given industry. With the advances in technology over the last decade, many industries are seeing the impact of winner-take-all dynamics leading to the result of greater concentration.