Most investors understand the importance of diversification in building a portfolio that’s resilient to various market conditions and able to more consistently meet investment objectives over time. Nonetheless, in the decade preceding the global disruptions of 2022, fear of missing out on the seemingly persistent growth of the 60/40 portfolio left many investors without sufficient diversification—right before it was needed most. Global macro emerged as a standout in 2022 amid a dispersion in results across various alternative investment styles.
Macro strategies generally posted strong gains in 2022. Have I missed the opportunity?
Macro is designed to be a strategic, persistent allocation that adds value over a full market cycle (including bear and bull markets) and should not be timed. Rather than trading in and out of strategies, investors are generally better served by constructing a well-diversified portfolio of low-correlated strategies with a long-term horizon.
What’s the opportunity set for macro looking forward?
Current macroeconomic conditions represent a sea change to the previous decade of quantitative easing, when every macro shock was met with an accommodative monetary policy response. This created the backdrop to the phenomenal performance for beta that we had until recently. However, the current macroeconomic backdrop presents a unique challenge as instead of responding to downside risks with more accommodation, central banks have been tightening financial conditions even in the face of weak risk assets, effectively turning from shock absorbing to shock amplifying. The complexity of this environment continues to underscore the importance of a properly diversified portfolio that comprises strategies that complement traditional investments.
Thematic opportunities for macro
- Oscillating financial conditions: If the United States avoids a recession, financial conditions will need to tighten considerably, creating a volatile backdrop that we believe may be advantageous for macro. Conversely, the dynamics of a recession, the bust and subsequent recovery of risk assets, the inversion and then steepening of the yield curve, and currency moves that are a consequence of asynchronous economic cycles in different countries may create opportunities for macro as well.
- Geopolitical dynamics: In our opinion, geopolitical shifts will continue to develop between dominant economies, such as the United States and China, and in the wake of the Russian/Ukraine crisis. Broader repositioning across global markets is expected to be favorable for active, directional strategies such as macro.
- Inflation and divergence in real yields: While big moves have taken place in some economies as a result of inflation, other central banks are still behind the curve and policy adjustments will continue to move markets, creating pockets of opportunity we believe for macro trading.
What if markets reverse course?
Given the unpredictable nature of global events, it’s reasonable to ask how macro strategies might fare under a reversal of market moves. Fortunately, the tactical nature of macro strategies and the diverse, generally liquid market universe allow flexibility in trading evolving market themes. At its core, macro is a dynamic and tactical strategy that can adapt to a variety of market conditions. The strategy isn’t reliant on either economic growth or contraction, inflationary or deflationary environments, or bullish or bearish equity markets, to name a few scenarios. If any or none of these circumstances emerge, the strategy should continue to add value to a diversified investment portfolio over the long run. And, as market conditions continually change and market uncertainty is high, the best way to construct a portfolio resilient to changing market regimes is through proper diversification, active risk management, and thoughtful portfolio construction. Market correlations can be concentrated at times, as seen in 2022, and allocating to strategies with low correlation to stocks and bonds that have the ability to go long and short a variety of asset classes will be important to helping manage risk going forward.
When is the best time to mitigate equity risk?
Equity cycles are notoriously difficult to predict. Some equity crises are short and sharp with intramonth recovery periods, whereas others are protracted and can take years to recover. As macroeconomic events continue to transpire, the range of potential market outcomes remains wide, and the spectrum of risk to which an investor is exposed is greater than ever. There is also reason to believe that the next upcycle for stocks and bonds may be more modest going forward. The decade preceding 2022 stands out as a particularly lucrative time for the 60/40 portfolio, particularly when looking at the returns in the context of a longer history; however, inflation can weigh on stocks and bonds when combined with hawkish monetary policy. As the macroeconomic paradigm shifts, many investors are shifting away from the long-only beta that disproportionately dominated portfolios throughout so many years of stability. It’ll be paramount for investors to allocate to strategies that can perform well in volatile environments and that tend to add to the overall alpha and diversification characteristics of a portfolio.
A look back at 60/40 returns
Source: eVestment and Graham Capital Management, L.P., January 2023. See important disclosures for more information. Past performance does not guarantee future results.
How does macro perform during equity drawdowns?
Macro strategies don’t have an embedded bias to be long or short any given asset class, including equities. Over the longer term, macro tends to have low correlation to equities, providing the potential to perform well during periods of sustained stress in global equity markets. While macro has historically performed well, on average, during equity sell-offs, positive performance during equity downturns isn’t guaranteed and macro shouldn’t be treated exclusively as a portfolio hedge. For example, while macro was a good hedge during longer-term market declines such as the burst of the technology bubble, the 2008 Global Financial Crisis, and the 2022 equity market drawdown, sharp reversals and short-term declines can be challenging, as seen in Q1 2020.
Potential to mitigate risk: performance during largest five equity drawdowns
Source: eVestment and Graham Capital Management, L.P., January 2023. It is not possible to invest directly in an index. Past performance does not guarantee future results.
What’s volatility got to do with it?
Prior to March 2020, markets experienced a long period of low volatility, which many believe dampened the opportunity set for macro strategies. Many see market volatility as a barometer for macro strategies’ success. Macro returns are closely linked to directional volatility due to expansions of ranges and price movement into new areas. For this reason, it’s true that macro can thrive in periods of high market volatility. However, it should be noted that the strategy can perform well in low volatility regimes as well. Macro returns strongly correspond to sustained directional moves in markets. Macro performs well during periods of strong market directionality, especially when there is a clear catalyst for market shifts. Shorter-term market volatility that often results in choppy, range-bound markets can be more challenging for the strategy. While it’s impossible to predict the level of directionality in markets in the coming years, we do anticipate several major macro catalysts, which may create sustained directional opportunities in markets.
Performance across volatility regimes
HFRI Macro Index, average quarterly return 1/90–12/22
Source: CBOE, HFR, Inc., and Graham Capital Management, L.P., January 2023. See important disclosures for more information. It is not possible to invest directly in an index. Past performance does not guarantee future results.
How can macro help with portfolio volatility?
The diversification properties of macro strategies result in the potential to reduce overall volatility and drawdowns of a broader investment portfolio. Macro—in particular—tends to exhibit a positively skewed performance distribution. Positive skew is desirable because the strategy tends to exhibit more positive extremes than negative, with potentially many instances of smaller return periods in between. These positive extremes often occur when there are clear catalysts for directional market moves, which can be either bullish or bearish, and offer the potential to offset drawdowns elsewhere in a portfolio. In other words, macro can be a big contributor when the portfolio is under stress, and may not be a big drag during periods when the portfolio is performing well. This is true dynamic diversification.
Is my bond investment enough to provide diversification and reduce volatility?
Long held as a staple for equity risk mitigation, bonds were unable to provide the greatly anticipated diversification benefits in 2022 as they declined in tandem with equities. Equity/bond relationships are not static, and there have been extended periods of positive stock/bond correlation. Today, the protective character of bonds is in jeopardy and investors may see positive correlations between stocks and bonds.
Elevated inflation presents a significant risk to stock/bond portfolios in terms of asset valuation, erosion of real returns, and positive correlation. When inflation rises, real yields decline alongside the market price of bonds, driving stock/bond correlations up.
As inflation persists in tandem with monetary tightening, bond investors may see lower returns and elevated volatility, decreasing bond utility as a safe haven.
How does macro perform in an inflationary environment?
Macro strategies can perform well in inflationary or noninflationary regimes and can capitalize on increasing commodity prices during inflationary periods. At its core, global macro is a dynamic and tactical strategy that may adapt to a variety of market conditions and may flourish at times of big dislocations. For example, macro managers were broadly successful in the 2022 inflationary market environment, as they were able to capitalize on strong market directionality and fundamental catalysts.
My hedge fund investment didn’t work out as expected in 2008—how is macro different?
Many investors seek diversification through alternative strategies; however, not all alternatives provide the expected portfolio diversification benefits. Diversification benefits vary significantly across styles, and many strategies have positive correlation during equity down markets. Macro is an uncorrelated, diversifying strategy that’s also designed to act as an alpha component. Irrespective of the economic cycle, the strategy can participate in market rallies and also perform well in falling markets, including equity stress periods.
Performance across the market cycle
Macro strategies typically have a low correlation to other alternative strategies and to traditional asset classes, such as equities and fixed income. Macro is most effective as a strategic allocation within a diversified investment portfolio that tends to stabilize portfolios during periods of stress, with the added potential for capturing alpha during market upturns. As a strategy that has the potential to offer true dynamic diversification, macro is worth investors’ consideration through market cycles.
Diversification does not guarantee a profit or eliminate the risk of a loss. 60/40 returns reflect the annualized returns of a portfolio with a 60 allocation to equities and a 40 allocation to bonds as represented by the MSCI World Index and the Bloomberg Global Bond Index, respectively, rebalanced monthly Real returns reflects the excess returns over inflation, as represented by U.S. Consumer Price Index (non seasonally adjusted).
The MSCI World Index tracks the performance of publicly traded large- and mid-cap stocks of developed market companies. Macro strategies are represented by the HFRI Macro Index, which involves investing by making leveraged bets on anticipated price movements of stock markets, interest rates, foreign exchange, and physical commodities. Trend following is represented by the HFRI Institutional Trend Following Directional Index, a global, equal-weighted index of single-manager funds that employ macro trend-following. Relative value is represented by the HFRI Relative Value Index, which maintains positions in which the investment thesis is predicated on realization of a valuation discrepancy in the relationship between multiple securities. Emerging markets are represented by the HFRI Emerging Markets (EM) (Total) Index, a global index of securities or the sovereign debt of developing or emerging countries. Event driven is represented by the HFRI Event Driven Directional Index, a global, equal-weighted index of single-manager funds that are classified as special situations, credit arbitrage, and distressed funds. Credit is represented by the HFRI Credit Index, which is a composite index of strategies trading primarily in credit markets. Equity hedge is represented by the HFRI Equity Hedge Index, which tracks multistrategy investment managers who maintain long and short positions of no more than 50% in primarily equity and equity-derivative securities. Hedge fund composite is the HFRI Fund Weighted Composite Index, a global, equal-weighted index of single-manager funds that report to HFR Database monthly net of all fees performance in U.S. dollars. It is not possible to invest directly in an index.
Alternative investments by their nature involve a substantial degree of risk, including the risk of total loss of an investor's capital. Further, alternative investments are subject to less regulation than other types of pooled investment vehicles, may be illiquid, and cannot assume that investments in the asset classes identified will be profitable or that decisions we make in the future will be profitable. Alternative investments may also involve significant use of leverage, making them substantially riskier than other investments.
Alternative investing involves substantial risk and there is an opportunity for significant losses. The products may not be suitable for all investors. Compared with a traditional mutual fund, an alternative fund typically holds more nontraditional investments and employs more complex trading strategies. Investors considering alternative mutual funds should be aware of their unique characteristics and risks. Alternative investments may also have limited performance information, low liquidity, and unproven strategies with unknown risks.
Alpha measures the difference between an actively managed fund's return and that of its benchmark index. An alpha of 3, for example, indicates the fund’s performance was 3% better than that of its benchmark (or expected return) over a specified period of time. Beta measures the sensitivity of the fund to its benchmark. The beta of the market (as represented by the benchmark) is 1.00. Accordingly, a fund with a 1.10 beta is expected to have 10% more volatility than the market. Quantitative easing (QE) is a monetary policy in which a central bank purchases government debt or other fixed-income securities in an effort to lower interest rates, increase the money supply, and stimulate economic growth.
Diversified Macro Fund
Quantitative models may not accurately predict future market movements or characteristics, which may negatively affect performance. The use of hedging and derivatives could produce disproportionate gains or losses and may increase costs. The fund’s use of derivatives may result in a leveraged portfolio that may not be successful and may create additional risks, including heightened price and return volatility. Exposure to commodities and commodities markets may also subject the fund to greater volatility than investments in traditional securities. Commodity investments can be volatile and are affected by speculation, supply-and-demand dynamics, geopolitical stability, and other factors. Large company stocks may underperform the market as a whole. Foreign investing has additional risks, such as currency and market volatility and political and social instability. The securities of small companies are subject to higher volatility than those of larger, more established companies. Fixed-income investments are subject to interest-rate and credit risk; their value will normally decline as interest rates rise or if an issuer is unable or unwilling to make principal or interest payments. The extent to which a security may be sold or a derivative position closed without negatively affecting its market value may be impaired by reduced market activity or participation, legal restrictions, or other economic and market impediments. By investing in a subsidiary, the fund is indirectly exposed to the risks associated with the subsidiary’s investments and operations. The tax treatment of commodity-related investments and income from the subsidiary may be adversely affected by future U.S. tax legislation, regulation, or guidance. Please see the fund’s prospectus for additional risks.
Alternative Asset Allocation Fund
The fund’s performance depends on the advisor’s skill in determining asset class allocations, the mix of underlying funds, and the performance of those underlying funds. The fund is subject to the same risks as the underlying funds and exchange-traded funds in which it invests: Stocks and bonds can decline due to adverse issuer, market, regulatory, or economic developments; foreign investing, especially in emerging markets, has additional risks, such as currency and market volatility and political and social instability; the securities of small companies are subject to higher volatility than those of larger, more established companies; and high-yield bonds are subject to additional risks, such as increased risk of default. Liquidity—the extent to which a security may be sold or a derivative position closed without negatively affecting its market value, if at all—may be impaired by reduced trading volume, heightened volatility, rising interest rates, and other market conditions. Currency transactions are affected by fluctuations in exchange rates. The fund’s losses could exceed the amount invested in its currency instruments. Please see the fund’s prospectus for additional risks.
This material is for informational purposes only and is not intended to be, nor shall it be interpreted or construed as, a recommendation or providing advice, impartial or otherwise. John Hancock Investment Management and our representatives and affiliates may receive compensation derived from the sale of and/or from any investment made in our products and services.
The views expressed are those of the author(s) and are subject to change. No forecasts are guaranteed. This commentary is provided for informational purposes only and is not an endorsement of any security, mutual fund, sector, or index.
Investing involves risks, including the potential loss of principal. A portfolio concentrated in one sector or that holds a limited number of securities may fluctuate more than a diversified portfolio.