Macro strategies: providing valuable diversification in a challenging market environment
In the current investment landscape, macro strategies may present an important portfolio construction tool for investors seeking an alternative means to enhance returns, reduce volatility, and maintain diversification. We look at how macro strategies could form part of a broader investment portfolio.
Potential macro themes driving markets in 2022
Heightened market uncertainty and volatility in the early stages of 2022 underscore the need for diversification, active risk management, and tactical trading that has the potential to enhance returns. In our opinion, several current macroeconomic themes support incorporating a macro trading strategy as part of a wider investment portfolio.
Diminishing return potential of bonds, record equity valuations
Alternatives—and specifically macro trading strategies—have the potential to offer diversification to both equities and bonds, as well as positive returns. With government bond yields at persistent historic lows, the return potential of bonds has diminished. Higher inflation inevitably depreciates the value of holding bonds. Meanwhile, the continuation of an equity rally is marked with uncertainty as geopolitics, supply chain issues, inflation, and tightened monetary policy present key downside risks to markets in 2022.
Diminishing return potential of bonds, record equity valuations
S&P 500 Index price level, 10-year U.S. Treasury bond yield, January 1990–December 2021
Source: Bloomberg, Graham Capital Management, December 2021.
The search for diversification
With little yield and less scope perhaps for price appreciation, investors today may hold on to bonds for low-cost protection during crisis periods rather than for an impactful return; however, it’s far from certain that negative stock/bond correlations will carry forward. Correlations aren’t static, and bonds don't always diversify equity risk. In fact, there have been extended periods when correlation between the asset classes has been positive.
Long-term stock and bond correlation
S&P 500 Index, 10-year U.S. Treasury bonds, December 1920–December 2021
Source: Robert Shiller database, Graham Capital Management, December 2021. 5-year rolling correlation between the S&P 500 Index and 10-year U.S. Treasury bonds.
In 2021, there were periods of elevated correlations across a wide array of markets. Investing in diversifying strategies—such as certain macro trading strategies that have the ability to go long and short and that trade a wide range of markets—may help to offset this concentration risk.
From an asset allocation perspective, investors reevaluating the role of fixed income may want to consider allocations to alternative strategies that ideally have positive long-term return potential and diversifying characteristics during difficult equity environments.
The role of macro in an investment portfolio
Macro strategies can profit across a variety of market environments due to their ability to go long and short a diverse, generally liquid market universe, and flexibility in trading evolving market themes. This may result in low correlation to stocks and bonds over the long term and the potential for positive returns; however, returns may be more modest in isolation and are meant to complement—rather than compete with—traditional assets such as equities. Ultimately, these strategies can have more muted returns and even a slight positive correlation to equities, yet may still offer significant diversification benefits.
Macro strategies typically have low correlation to other asset classes
Source: eVestment, Graham Capital Management, December 2021.
Potential benefits of allocating to macro
|Increase overall returns||Improve risk-adjusted returns||Lower overall volatility||Reduce drawdowns||Reduce beta to equities|
|Annualized return||Information ratio||Annualized volatility||Worst drawdown||Beta to equities|
|Traditional 60/40 portfolio||5.74||0.57||10.06||36.09||0.64|
|HFRI Macro Index||4.58||0.91||5.06||8.02||0.10|
|Traditional portfolio with 10% HFRI Macro Index||5.91||0.69||8.55||31.38||0.55|
Macro strategies are a potentially valuable portfolio construction tool that have the potential to lower the volatility and soften the drawdowns of an overall portfolio, while adding to returns over the long run. And while it’s unreasonable to expect the strategy to perform well at every discrete point in time, holding the strategy as a long-term strategic allocation in a diversified investment portfolio offers the potential for significant benefits.
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.
The S&P 500 Index tracks the performance of 500 of the largest publicly traded companies in the United States. The MSCI World Index tracks the performance of publicly traded large- and mid-cap stocks of developed-market companies. The Bloomberg U.S. Aggregate Bond Index tracks the performance of U.S. investment-grade bonds in government, asset-backed, and corporate debt markets. The Bloomberg Global Aggregate Bond Index tracks the performance of global investment-grade debt in fixed-rate treasury, government-related, corporate, and securitized bond markets. The Bloomberg Global Bond Index tracks the performance of global investment-grade debt in fixed-rate treasury, government-related, corporate, and securitized bond markets. The HFRI Macro Index involves investing by making leveraged bets on anticipated price movements of stock markets, interest rates, foreign exchange, and physical commodities. Correlation is a statistical measure that describes how investments move in relation to each other, ranging from -1.0 to 1.0. Values closer to 1.0 show positive correlation where investments move in the same direction as each other at the same time. Values closer to -1.0 show negative correlation, where investments move in opposite directions to each other. It is not possible to invest in an index. Past performance does not guarantee future results. Diversification does not guarantee a profit or eliminate the risk of a loss.