Monday, March 28, 2016

Global macro - Bottom-up or top-down; two views of trading

Global macro is a very broad hedge fund category which does not lend itself to easy descriptions. Nevertheless, we can take a simple stab and divide global macro into top-down and bottom-up approaches. This is a variation of how many stock-pickers behave but reset to a global macro environment. The distinction is important because the return and risk profiles should be different based on the approach taken.

We don't want to make a value judgement about which is better other than to say that each will generate a different return pattern. The top-down approach approach tries to exploit buying (selling) cheap (rich) beta. The bottom-up approach is looking for alpha opportunities across a global set of markets.

The top-down global macro manager will focus on major themes in markets and look to take directional bets on the market. Are European stocks cheap relative to the US? Is inflation rising? Will the Fed raise rates? These can be exploited in the futures markets as directional bets. The portfolio will be a combination of long and short beta bets base don macro factors in liquid market that have easily identifiable risk premiums.

The bottom up approach may have a macro view but will be looking for market dislocations or mis-pricings to exploit. A fall in energy prices may effect the Canadian banks. A rise in rates may have a big impact on levered loans. A macro theme may be identified but the manner the risk is taken is micro structured around specific controlled opportunities.The portfolio bets are combination of macro themes expressed through assets that may be mis-priced. The return to risk profile is sculpted and focused on specific opportunities.

The top-down manager is trying to exploit beta opportunities while the bottom-up manager is focused on finding or creating alpha opportunities across global markets. Put another way, the top-down manager is trying to exploit dynamic beta opportunities. By changing the risk profile of the portfolio, the manager expects to generate a higher return than a globally diversified portfolio.

There are risk premiums across global asset classes. The top-down manager tries to forecast the direction and relative value of these premiums because they they are time varying. The business cycle, the credit cycle, or liquidity cycle all change risk premium so an astute macro manager will change exposures to exploit these changes with higher compensation to risk. In the simplest form, this could be a trend-follower who is exploiting momentum across asset classes. A more sophisticated form will be using option strategies to change limit downside risk. 

The bottom-up global macro manager is not focused on trends in risk premiums across asset classes, but focused on using the global macro environment to find opportunities of mis-pricing across asset classes. Is the yield curve fully pricing in Fed action and are there points along the curve that can be exploited cheaply. There will be a set of micro-bets that may not be correlated with macro price moves in asset classes but will depend on some change in the macro environment. 

Now, let's be clear, we have outline the extremes of macro investing. In many cases, there is will be global macro managers who combine both searching for alpha opportunities will export changes is risk premiums. Nevertheless, it is good to start with a simple classification scheme to start a global macro discussion.

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