Financial pundits love a good catchphrase, and one that has gained traction of late is “higher for longer.” In an effort to curb inflation, the Federal Reserve has hiked rates 11 times since March of 2022, raising the fed funds rate 525 basis points.1 In the EU, the European Central Bank (ECB) deposit rate reached a record high of 4% in September 2023, a stark contrast from 0% in July of 2022.2 Yet despite central banks’ efforts, inflation remains problematic for consumers and may force policymakers to maintain interest rates at current or potentially higher levels in order to combat elevated prices across the global economy.
Higher interest rates have an impact on all major asset classes. In equities, over time it widens the dispersion of stocks, differentiating between companies that can effectively handle their capital needs versus those that struggle without the free money lifeline. Shareholders are less willing to invest in highly speculative, longer-dated equities and instead look to companies with a more defined path towards sustained earnings growth.
In credit, companies face higher borrowing costs and tighter loan standards, creating a difficult environment to service and refinance debt, leading to dislocations and heightened volatility globally. According to Goldman Sachs, U.S. companies are expected to see a 7.5% increase in their interest expense over the next two years, which will have a dramatic impact on sub-investment grade issuers with looming debt maturities.3
Similarly, in developed and emerging currencies and across the commodities asset classes, the level of interest rates in different countries influences numerous macroeconomic indicators that were largely irrelevant in a world of zero rates. With interest rates higher across the globe, currency volatility – and by extension, investment opportunities – is likely to remain robust as central banks address their own country’s “fight inflation vs. sustain growth” dilemma in a less synchronized manner as compared to the prior decade. One recent case in point – the Japanese yen is trading again at 30-year lows against the U.S. dollar amidst calls for government intervention.4
Attractive Environment for Macro
So, if interest rates are likely to stay higher for longer, which strategies are poised to benefit? Macro investing, executed on a discretionary or systematic basis, has historically performed best when interest rates are higher, when volatility is elevated, and often when traditional asset-only portfolios suffer.
The fiscal strain and widening dispersion in stock performance, as well as shifting fixed income yields/pricing and volatility in global currencies, provide macro hedge fund managers an opportunity to outperform. Returns for macro hedge fund managers are primarily driven by large market and price movements in either direction, providing macro investors the opportunity to generate uncorrelated returns, regardless of the direction of risk assets. This further demonstrates the benefit of macro hedge funds – in addition to their significant liquidity and multi-asset class diversification, they tend to outperform not only when only stocks and bonds falter, but more typically when volatility and uncertainty are heightened.
Diversification in Traditional-Asset Portfolios
One of the most significant benefits from non-correlated hedge fund strategies like macro is diversification, particularly when equities and bonds in traditional asset- only portfolios are moving in tandem. When the 60 and 40 are positively correlated (particularly on the downside), this portfolio benefit increases dramatically.
September is historically the worst month of the year for stocks, and thus far 2023 has been no exception, with the S&P 500 Index, Russell 2000 Index, Nasdaq Composite Index, and MSCI World Index all down more than 4%.5 September was also the worst month of the year for bonds, with the Bloomberg U.S. Aggregate Bond Index and Bloomberg Global Aggregate Bond Index down -2.54% and -2.92%, respectively.6
Since January of 2022, the S&P 500 Index has declined 10 times, and every time equities have declined, bonds have fallen.7 While traditional long-only investors were negatively impacted by the positive correlation between stocks and bonds, macro hedge funds delivered positive returns 7 out of the 10 months equities and bonds fell in tandem, and provided meaningful downside protection in the 3 other periods.8
Conclusion
From our vantage point, while we may be nearing the end of rising interest rates, investors are still assessing the implications of a sustained period of higher rates, one that may last longer than many have anticipated. In this environment, higher interest rates will impact stocks and bonds, currencies, and commodities very differently, providing strategic and tactical investment opportunities for skilled portfolio managers to drive returns in an uncorrelated manner. By capturing those return-generating opportunities, we believe macro hedge funds should continue to drive value in client portfolios.
ENDNOTES
1. Federal Reserve, as of Oct. 6, 2023.
2. European Central Bank, Key ECB Interest Rates, as of Oct. 6, 2023.
3. Goldman Sachs Global Investment Research, The Corporate Debt Maturity Wall: Implications for Capex and Employment, Aug. 6, 2023.
4. Reuters, Japan Keeps Markets Guessing on Yen Intervention, Warns Against Sharp Falls, Oct. 4, 2023.
5. Bloomberg, as of Oct. 9, 2023. S&P 500 Index down -4.87%, Russell 2000 Index down -6.03%, Nasdaq Composite Index down -5.81%, and MSCI World Index down -4.45%.
6. Bloomberg, as of Oct. 9, 2023.
7. eVestment, as of Oct. 10, 2023.
8. eVestment, as of Oct. 10, 2023. Macro hedge funds represented by the HFRI Macro Total Index.
INDEX DEFINITIONS
Credit Suisse Event-Driven Index: A subset of the Credit Suisse Hedge Fund Index that measures the aggregate performance of Event-Driven funds. Event-Driven funds typically invest in various asset classes and seek to profit from potential mispricing of securities related to a specific corporate or market event. Such events can include: mergers, bankruptcies, financial or operational stress, restructurings, asset sales, recapitalizations, spin-offs, litigation, regulatory and legislative changes as well as other types of corporate events. Event-Driven funds can invest in equities, fixed income instruments (investment grade, high yield, bank debt, convertible debt and distressed), options and various other derivatives. Many Event-Driven fund managers use a combination of strategies and adjust exposures based on the opportunity sets in each subsector.
Credit Suisse Global Macro Index: A subset of the Credit Suisse Hedge Fund Index that measures the aggregate performance of global macro funds. Global macro funds typically focus on identifying extreme price valuations and leverage is often applied on the anticipated price movements in equity, currency, interest rate and commodity markets. Managers typically employ a top-down global approach to concentrate on forecasting how political trends and global macroeconomic events affect the valuation of financial instruments. Profits can be made by correctly anticipating price movements in global markets and having the flexibility to use a broad investment mandate, with the ability to hold positions in practically any market with any instrument. These approaches may be systematic trend following models, or discretionary.
Credit Suisse Hedge Fund Index: An asset-weighted hedge fund index that includes only funds, as opposed to separate accounts. The index uses the Credit Suisse Hedge Fund Database, which tracks approximately 9,000 funds and consists only of funds with a minimum of US$50 million under management, a 12-month track record, and audited financial statements. The index is calculated and rebalanced on a monthly basis, and reflects performance net of all hedge fund component performance fees and expenses.
Credit Suisse Long/Short Equity Index: A subset of the Credit Suisse Hedge Fund Index that measures the aggregate performance of long/short equity funds. Long/short equity funds typically invest in both long and short sides of equity markets, generally focusing on diversifying or hedging across particular sectors, regions, or market capitalizations. Managers typically have the flexibility to shift from value to growth; small to medium to large capitalization stocks; and net long to net short. Managers can also trade equity futures and options as well as equity related securities and debt or build portfolios that are more concentrated than traditional long-only equity funds.
Credit Suisse Multi Strategy Index: A subset of the Credit Suisse Hedge Fund Index that measures the aggregate performance of multi-strategy funds. Multi-strategy funds typically are characterized by their ability to allocate capital based on perceived opportunities among several hedge fund strategies. Through the diversification of capital, managers seek to deliver consistently positive returns regardless of the directional movement in equity, interest rate or currency markets. The added diversification benefits may reduce the risk profile and help to smooth returns, reduce volatility, and decrease asset-class and single-strategy risks. Strategies adopted in a multi-strategy fund may include, but are not limited to, convertible bond arbitrage, equity long/short, statistical arbitrage, and merger arbitrage.
HFRI Macro Total Index: Includes investment managers which trade a broad range of strategies in which the investment process is predicated on movements in underlying economic variables and the impact these have on equity, fixed income, hard currency, and commodity markets. These managers employ a variety of techniques, both discretionary and systematic analysis, combinations of top down and bottom up theses, quantitative and fundamental approaches and long and short term holding periods.
IMPORTANT INFORMATION
The material herein has been provided to you for informational purposes only by Institutional Capital Network, Inc. (“iCapital Network”) or one of its affiliates (iCapital Network together with its affiliates, “iCapital”). This material is the property of iCapital and may not be shared without the written permission of iCapital. No part of this material may be reproduced in any form, or referred to in any other publication, without express written permission of iCapital.
This material is provided for informational purposes only and is not intended as, and may not be relied on in any manner as, legal, tax or investment advice, a recommendation, or as an offer or solicitation to buy or sell any security, financial product or instrument, or otherwise to participate in any particular trading strategy. This material does not intend to address the financial objectives, situation, or specific needs of any individual investor. You should consult your personal accounting, tax and legal advisors to understand the implications of any investment specific to your personal financial situation.
ALTERNATIVE INVESTMENTS ARE CONSIDERED COMPLEX PRODUCTS AND MAY NOT BE SUITABLE FOR ALL INVESTORS. Prospective investors should be aware that an investment in an alternative investment is speculative and involves a high degree of risk. Alternative Investments often engage in leveraging and other speculative investment practices that may increase the risk of investment loss; can be highly illiquid; may not be required to provide periodic pricing or valuation information to investors; may involve complex tax structures and delays in distributing important tax information; are not subject to the same regulatory requirements as mutual funds; and often charge high fees. There is no guarantee that an alternative investment will implement its investment strategy and/or achieve its objectives, generate profits, or avoid loss. An investment should only be considered by sophisticated investors who can afford to lose all or a substantial amount of their investment.
iCapital Markets LLC operates a platform that makes available financial products to financial professionals. In operating this platform, iCapital Markets LLC generally earns revenue based on the volume of transactions that take place in these products and would benefit by an increase in sales for these products.
The information contained herein is an opinion only, as of the date indicated, and should not be relied upon as the only important information available. Any prediction, projection or forecast on the economy, stock market, bond market or the economic trends of the markets is not necessarily indicative of the future or likely performance. The information contained herein is subject to change, incomplete, and may include information and/or data obtained from third party sources that iCapital believes, but does not guarantee, to be accurate. iCapital considers this third-party data reliable, but does not represent that it is accurate, complete and/or up to date, and it should not be relied on as such. iCapital makes no representation as to the accuracy or completeness of this material and accepts no liability for losses arising from the use of the material presented. No representation or warranty is made by iCapital as to the reasonableness or completeness of such forward-looking statements or to any other financial information contained herein.
Securities products and services are offered by iCapital Markets, an SEC-registered broker-dealer, member FINRA and SIPC, and an affiliate of iCapital, Inc. and Institutional Capital Network, Inc. These registrations and memberships in no way imply that the SEC, FINRA, or SIPC have endorsed any of the entities, products, or services discussed herein. Annuities and insurance services are provided by iCapital Annuities and Insurance Services LLC, an affiliate of iCapital, Inc. “iCapital” and “iCapital Network” are registered trademarks of Institutional Capital Network, Inc. Additional information is available upon request.
© 2024 Institutional Capital Network, Inc. All Rights Reserved. | 2024.01.
