We at The Macro Trader are obviously fans of Global Macro as an investment strategy and even philosophy. Fortunately the data backs us up showing that global macro not only generates higher returns but does it with far lower risk than equities.
The chart below shows how you would have done if you had invested $1,000 into the Credit Suisse Macro Hedge Fund Index, SP500, and Barclays Aggregate Bond Index since 1994. As you can see the CS Macro Hedge Fund Index did drastically better than either stocks or bonds. To be more specific the CS Macro Index beat the SP500 by 2.11 times and the AGG Index by 2.75 times. So that shows the returns but what about the risk taken to achieve these returns?
We have a few different charts to display the risks taken to generate the returns in each index. First we will show the historical drawdown charts. A drawdown is simply anytime you are not at new highs in your account. If you have $100 and lose $5 you are in a -5% drawdown. The deeper the drawdown the higher the return needed to get back to breakeven and the math, while simple, can be tricky. For instance if you lose -50% many think you need to make 50% to get to breakeven. The reality is that you need 100% to get to breakeven. In our case of being down -5% you only need a 5.26% return to get to breakeven but it gets harder the deeper you get.
Looking at a drawdown chart of the SP500 you can see that not only are stocks usually in a drawdown but over the past 20+ years we have had two massive drawdowns that took years to make up. We know them as the DotCom crash and the GFC-Global Financial Crisis. It took the SP500 57 months to recover from the DotCom crash and 50 months to recover from the GFC.
At the opposite end of the spectrum we have the drawdowns of the Barclays AGG Fixed Income Index. As you can see the AGG Index has frequent but small drawdowns with the worst one barely dropping below -5%. It only took nine months for the AGG index to fully recover from the worst drawdown and three months to recover from the second deepest drawdown.
Finally we have the CS Global Macro Index drawdowns. As you can see its worst drawdown was a -26.79% and its second worst was -14.94%. It took 19 months to recover from the -26% drawdown and 19 months to recover from the -14.94% drawdown.
Another way to show the depth and length of the drawdowns is to plot both the equity line as well as the new highs line. In each of the next three charts the green line equals the highest the equity line got, notice it never dips down, and the red line is the equity curve which goes both up and down.
Here is the SP500. As you can see while it hit a new high in 2007 it then went back down. In essence it took about 12 years before investors were really making new money. While this is a worse than “normal” period it is also not the first or the second time that the stock market has had a rough decade.
Looking at the AGG Fixed Income Index we see that the drawdowns are both shallow and short. If you were in the AGG Index you would not make the most money but you also took very little risk.
Finally we have the CS Global Macro Index. As you can see the drawdowns while larger than that of the AGG index are far smaller than the SP500 index. It kind of takes the middle route in regards to risk but it drastically outperforms both in regards to return.
Another way to look at the risk and return is to look at the 12-Month Rolling Returns. At any point in the chart you are looking at the returns you would have gotten if you had invested 12-Months ago. As you can see the SP500-red line has the highest 12-Month returns but also the lowest 12-Month returns. The AGG Index-green line almost always shows positive returns but it never has a really big year. Finally the CS Macro Index-blue line again comes somewhere in the middle. It is positive almost as often as the bond index but the 12-Month period to 12-Month period returns are less than stocks.
Basically global macro has lower volatility and more consistent returns than the stock market and almost as consistent returns and far more gains than the bond market. The main reason that this is possible is that as opposed to either the stock or bond index a global macro fund can go long and short anything and trade derivatives on anything. Most macro managers stick to liquid instruments but that still means you have hundreds if not thousands of tradeable instruments. The flexibility inherent in global macro allows you to always find a bull market somewhere whether that is being long stocks, short stocks, long the Australian Dollar, or short the Australian Dollar. You can bet on US Treasuries against German Bunds or across almost any other market relationship you can think of. Not only is global macro flexible but macro managers are famous for stringent risk management practices. It is almost cliche but in the end risk management is one of the keys to success in any trading approach and one of the most important things that separate macro from long only buy and hold.
What about claims in the press that “hedge funds have under-performed the SP500 since the GFC?” Well that is true but if you are picking only half a cycle than it is probably not a fair comparison. In the chart below you can see what happened to the CS Macro Index and the SP500 from the end of 2008 until the end of August 2015. As you can see the stock market is ahead.
Of course that was just in a bull move when everything was headed up. If instead of the end of 2008 or the end of February 2009 we use 2007 as our starting point we get a drastically different result. In this case the flexibility and risk reduction inherent in the global macro approach shines as the CS Macro Index outperforms the SP500 with both higher returns and far lower risk.
As far back as we have data global macro has outperformed both stocks and bonds across full market cycle. On the other hand long only equities has been profitable but has had some very long and deep periods of negative returns. We are obviously biased towards global macro. We have a site and run a research service dedicated to it. You could say we drank the kool-aid and live and breathe this stuff. At the same time however many of the most successful money managers in history have been macro managers and the data shows that when done right it can lead to both higher absolute and risk adjusted returns. So while we are indeed biased we think that the case is fairly strong in our favor.