Hedge Fund Up 21% Sets Sight on Fed to Supercharge ReturnsBy
AE Capital’s systematic strategy based on tracking asset flows
Balance-sheet unwind to fuel currency swings, CI0 says
For the better part of a decade, global macro hedge funds have struggled to make money, complaining that central-bank policies have crimped volatility. That makes AE Capital’s success even more impressive.
The firm, which manages about $300 million in foreign-exchange strategies, relies on computer algorithms to track asset flows and identify currencies ripe for swings in sentiment. This year, wagers on the Canadian and Australian dollars versus the greenback have paid off handsomely, with returns in the Fully Geared Systematic FX Fund, its largest, topping 21 percent through mid-September. That’s after gains of 20 percent last year and 56 percent in 2015, and compares with returns of less than 1 percent for global macro funds broadly, according to Hedge Fund Research.
Now, Chief Investment Officer Lyle Pakula is betting that the Federal Reserve’s plans to begin reducing its $4.5 trillion balance sheet, an announcement on which is expected Wednesday, will bring a fresh dose of havoc to the foreign-exchange market, and he’s re-positioning his bets to take advantage. He’s adding risk exposure to the U.S. currency as the firm’s models show the greenback is ripe for turbulence.
“We’re not long or short the Fed normalizing -- we’re long the idea that Fed normalization is going to lead to gyrations in sentiment across several currencies in our current portfolio and that will lead to opportunities to profit,” Pakula said from Melbourne. “That exact indecision in the market is the kind of thing we like. People are changing their minds, they’re not sure of things, there are competing forces -- that’s bread and butter for us.”
The renewed turbulence may be a boon for global macro funds, which have faltered as the world’s central banks pursued loose monetary policies to stimulate growth in the aftermath of the financial crisis.
More recently, hedge funds have suffered as bets the dollar would surge with Treasury yields haven’t panned out amid the Trump administration’s lack of progress in enacting its fiscal promises, most notably tax reform. The U.S. currency has slumped 10 percent this year, on track for its biggest decline since 2003.
“The challenge for a lot of macro investors is that they were positioned somewhat similar, in that they were expecting a more choppy environment as a result of a clearer Fed tightening cycle, and the dollar has gotten absolutely crushed,” said Darren Wolf, head of hedge-fund solutions for the Americas at Aberdeen Asset Management, which oversees about $385 billion. “That was a reasonably consensus trade -- long dollar, short interest rates -- that’s been particularly painful. On top of that, macro managers generally need more volatility.”
Volatility has fallen alongside the greenback this year. The J.P. Morgan Global Volatility Index sank to the lowest level since 2014 in June, depressing returns for currency managers.
The gauge has since inched up, and that trend is likely to continue, according to Nick Bennenbroek at Wells Fargo Securities. With the Fed on the brink of announcing its balance-sheet plans and 2018 poised to be a more “active” year for central banks globally, volatility should rise through the end of next year, Bennenbroek said.
“It’s going to be hard for currency-market volatility to stay at such a muted level for such a long time,” he said. “I wouldn’t think we’ll revisit the highs of the European debt crisis or the global financial crisis, but I do think we’ll see volatility move higher, back to 2015, 2016 levels.”
AE Capital has navigated the low volatility environment by leaving the directional guesswork up to computer models, which track flows into different currencies to determine market sentiment. The firm will generally hold currency positions for just a few days or weeks at a time, allowing it to quickly seize on shifts in sentiment.
“Through the course of it, people are going to be flipping between ‘Is this good or bad?’ and that’s what we look for,” Pakula said. “We look for those sentiment shifts.”
Their approach is far from foolproof, of course. AE Capital’s fundamental-driven systematic trading strategy has struggled with the euro this year. The common currency has gained 14 percent against the dollar in 2017, a move that Pakula said is hard to explain given negative rates and the European Central Bank’s bond-buying program. The euro’s move fueled the Fully Geared fund’s 6.2 percent loss in August, as the currency rallied on expectations the ECB will taper asset purchases in 2018.
Bets against the euro have been offset by trades against the faltering dollar, which Pakula says are responsible for the bulk of 2017 profits thus far. In July, favorable positioning in the loonie and Aussie around the Bank of Canada’s rate hike and the Reserve Bank of Australia’s meeting minutes fueled gains of 3.5 percent.
With the start of the Fed’s balance-sheet unwind imminent, as well as increasing market expectations for a third rate hike by year-end, Pakula predicts the dollar will continue to drive AE Capital’s profits.
“What we’re thinking about going forward, it’s the U.S. market, it’s all the dollar,” Pakula said. “America’s the main game in town in the G-10.”
— With assistance by Katia Porzecanski, and Saijel Kishan