Macro Hedge Funds to Profit as Markets Brush Off ShocksKatherine Burton
At Caxton Associates LLC, an $11 billion hedge fund, Chief Investment Officer Andrew Law is betting on rising prices for commodities including oil. Fulcrum Asset Management LLP’s Gavyn Davies likes Japanese stocks.
Managers of macro hedge funds such as Law and Davies wager on broad economic trends, and they say 2011 is shaping up to be a promising year as big themes take hold, notably a pickup in global growth and rising interest rates outside of the U.S. Market volatility that stymied macro funds over the past two years is subsiding, as are concerns caused by Japan’s 9.0 magnitude earthquake and unrest in the Middle East.
“Macro managers make money in long-duration, low-volatility trending markets,” Davies, who uses both computer models and fundamental analysis to select investments for his $1.3 billion fund, said in a telephone interview from his London office. He expects markets to be easier to navigate this year for macro traders.
Returns by macro funds have lagged behind other strategies since outperforming in 2008, as managers struggled to predict the direction of markets in Europe, the U.S. and emerging economies after the financial crisis. The funds gained 17 percent on average from the start of 2009 through February 2011, compared with a jump of almost 23 percent by the broader industry index, according to data compiled by Bloomberg.
The top-performing category was funds that trade mortgage-backed bonds, which climbed 87 percent in the same period.
Macro managers, who attracted 12 percent of the $115.8 billion that went into hedge funds last year, got an additional $1.2 billion in January, the most recent month for which data is available, according to research firms TrimTabs Investment Research and BarclayHedge.
“We had high hopes for them in 2010, and most of them didn’t live up to our expectations,” said Pierre Merillon, head of macro research at Paris-based Darius Capital Partners, which helps institutions invest in hedge funds. Through February, gains by macro funds came mostly in commodities and equities, while currencies and fixed income were more challenging, he said.
In a sign that investors have become more confident about the global recovery, stocks worldwide have rebounded 5 percent since dropping to a low for the year on March 16, five days after Japan’s earthquake and tsunami, which crippled the Fukushima Dai-Ichi nuclear power plant. Markets have also shrugged off the impact of street protests in Bahrain and fighting in Libya that sent oil prices surging.
Betting on Japan
Davies, 60, whose macro fund returned 6 percent in 2008 and almost 26 percent over the following two years, said Japanese equities could climb 20 percent from current levels during the next 12 months, a target the former chief economist of Goldman Sachs Group Inc. calls “fairly conservative.”
Even before the earthquake and tsunami struck, initially sending the benchmark Japanese index down 18 percent, stocks were looking inexpensive relative to historic levels, he said. Japanese companies that comprise the Nikkei 225 Index are trading at 1.2 times book value, compared with a two-decade average of 2 times and the Standard & Poor’s 500’s current level of 2.3 times, according to Bloomberg data.
Japanese stocks also will be helped by a weaker yen, which Davies said may move closer to 90 yen to the dollar over the next 12 months, from 82.32 at 10:12 a.m. New York time today. Gross domestic product, which will probably take a hit in the third and fourth quarters of this year in the wake of the disaster, will rebound in 2012 as the country rebuilds areas destroyed by the quake and subsequent tsunami. The number of dead and missing from the earthquake and tsunami had reached 28,343 as of 9 p.m. yesterday in Tokyo.
Law, 44, whose $6.7 billion Caxton Global Investment fund, returned about 13 percent in 2008 and almost 16 percent over the following two years, expects rising prices for oil, liquefied natural gas and coal, as well as base metals and agricultural commodities, as global growth and inflation accelerate.
“The recent events in the Middle East and Japan in many ways reinforce the energy-price outlook as heavily skewed to the upside,” said Law, who is based in London. “Policy makers around the world are tolerant of higher inflation,” he said, as seen by the Bank of England allowing inflation to rise above its target and the Chinese raising wages.
Goldman Sachs forecasts global expansion of 4.8 percent this year, compared with an average of 3.4 percent over the past two decades.
In currencies, fund managers say they expect the U.S. dollar to weaken more against the euro because the U.S. hasn’t signaled plans to raise interest rates for at least the next year. Economists surveyed by Bloomberg forecast that the European Central Bank will raise its main refinancing rate by
0.25 percentage point at its next meeting on April 7.
“The ECB will tighten first and move significantly before the Fed, by 12 to 18 months and 200 basis points,” Davies said. “That’s not priced in yet.”
Davies predicted the euro, which has already climbed 6.5 percent in the past three months to $1.4083, may jump to $1.50. Law called the weakening dollar a “standout trend,” adding, “I don’t see any Western policy maker saying this is a problem.”
Some managers said the yen, which climbed to a post-World War II high against the dollar in the days following the earthquake, could prove the exception.
Philippe Bonnefoy, founder of Geneva-based Cedar Partners (Suisse) SA, which runs a short-term currency-trading fund, expects that the yen will remain around current levels for a few months and may even strengthen, as Japanese investors and insurance companies repatriate money and test the resolve of the Bank of Japan and other central banks to sell the currency, as they did on March 18. The longer-term trend will be a much weaker currency, he said.
“After this initial pressure we would expect to see a long, slow, multiyear devaluation of the yen as the long-term demographic and structural problems of Japan become more evident,” Bonnefoy said. “The Japanese government has no real ability to pay its bills,” he said, given that the number of workers is falling and the retiree population is growing.
The move could rival the yen’s decline from 1995 to 1998, when it went from close to 80 yen per U.S. dollar to around 145, he said.
Managers disagree about the strength of U.S. equities this year. Law forecasts that rising commodity prices will eventually cut into profits of U.S. companies and put pressure on their shares. Since the end of 2008, commodities and equities have moved more or less in tandem, whereas previously the correlation between the two markets had been relatively low, Law said. He expects a return to their historic relationship, where the correlation is as likely to be negative as positive.
David Gerstenhaber, who manages the $1.8 billion Argonaut Management LP in New York, said U.S. stocks may suffer in the second half of the year after the Federal Reserve’s $600 billion asset purchase program, known as quantitative easing or QE2, ends in June.
“There are various reasons to think that growth in the second half may be less robust,” he said, adding that in addition to the end of QE2, there will be less government spending at the federal and state levels.
While some bankers and investors have questioned the efficacy of quantitative easing, the S&P 500 Index has climbed 23 percent since Aug. 27, when Fed Chairman Ben S. Bernanke first said more securities purchases might be warranted.
Role of China
Davies said he believes that China’s efforts to reduce inflation will slow the economy there more than the world expects, driving stocks in developing nations lower. U.S. growth will continue and profit margins will widen, boosting equity prices, he said. U.S. shares will go higher as long as Brent crude, now trading at almost $115 a barrel, doesn’t go above $120 for nine months or more, Davies said.
China’s economic growth is forecast to slow to 8.2 percent in 2012 from 8.5 percent this year, according to the World Bank.
Darius Capital’s Merillon said he remains optimistic that current markets are good for macro funds. He acknowledges he could be disappointed again.
“Even though macro factors should be important market drivers in 2011, the timing of these events could prove hard to gauge,” he said.
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