Global Macro Strategy: A Guide
What is Global Macro
Global macro is an investment strategy used primarily by hedge funds to profit from broad economic and political shifts across the globe. These funds employ a top-down investment approach, starting with an evaluation of the overall global economic landscape and then drilling down by country, region, and asset class to identify investment opportunities. While this vast investable universe encompasses nearly any tradable asset worldwide, global macro managers typically focus on equity indices, currencies, government bonds, interest rates, and commodities.
Examples of Global Macro Strategies
Global macro strategies include a diverse range employed by investment funds to navigate and profit from macroeconomic and geopolitical trends across various asset classes and markets. Here, we explore three popular approaches: relative value, mean reversion, and momentum.
Relative value: in the context of global macro investing, relative value refers to the trading strategy where two similar assets are paired on the long and short sides to exploit a perceived relative mispricing. This strategy involves comparing the value of related assets to identify discrepancies in pricing and capitalize on them
Relative value trades can be applied across various asset classes and objectives. For instance, in equities, an investor might go short a specific industry sector and simultaneously long the overall market, anticipating that the sector will underperform the broader market. In fixed income, a trader might go long on a short-term bond and short a long-term bond issued by the same government, betting on a steepening yield curve.
While the core concept of relative value trading remains consistent across different types of strategies and managers, a key distinction lies in their approach: top-down vs. bottom-up. Global macro managers typically identify relative value opportunities on a macro level, focusing on comparisons like country-specific equity indices or currencies. In contrast, other investment managers, including those specializing in relative value strategies, tend to employ a more granular bottom-up approach, focusing on individual assets within a specific class, such as different maturities of U.S. Treasury securities.
Mean reversion: this refers to the investment strategy that capitalizes on the tendency of financial assets to revert to their historical mean or average price over time. This approach is based on the idea that asset prices will eventually return to their historical norms after periods of deviation. Global macro traders use mean reversion to identify assets that are significantly overvalued or undervalued and take positions based on the expectation that they will revert to their mean.
These types of trades, often directional, may be less prevalent in global macro portfolios during normal times. However, during market turbulence or crises, they can become the most prominent allocations. Market crises and crashes are widely seen as causing departures from equilibrium in asset values. So, when a global macro manager has a thesis about a market disruption, they can establish directional trades to capitalize on the asset's return to its historical average price or perceived fair value. So while relative value trades usually maintain a market-neutral stance, directional trades often embraces market risk.
Many investment managers built their reputations on directional bets. George Soros famously shorted the British pound in 1992, breaking the UK's peg to the European Exchange Rate Mechanism. Similarly, John Paulson recognized the inflated US housing market as a bubble in 2008. He used a complex financial instrument (CDO) to profit from the housing crash, earning significant gains when the bubble burst.
Momentum: Momentum strategies, in the context of systematic global macro, refer to "going long assets with improving macroeconomic fundamentals and short assets with deteriorating fundamentals," as outlined in an AQR paper. This approach often involves constructing models that analyze various timeframes and asset classes, including equities, currencies, fixed income, and interest rates. These models focus on macroeconomic variables that influence the performance of each asset class. Managers typically implement momentum strategies through long-short and directional portfolios.
Long-short portfolios take long positions in assets exhibiting positive macroeconomic trends and short positions in assets with negative macroeconomic trends, all relative to the overall market. They aim to remain market-neutral at all times. Conversely, directional portfolios hold long positions in assets with favorable macroeconomic trends and short positions in assets with unfavorable trends, regardless of the overall market direction. Although not always market-neutral in the short term, directional strategies are designed to be market-neutral on average.
Carry: A carry trade is a global macro strategy that involves borrowing in a low-yielding currency or security to invest in a higher-yielding currency or security. Popular carry trades include borrowing in Japanese yen to invest in higher-yielding currencies like the Australian dollar or New Zealand dollar.
The goal of carry trade is (1) to profit from the interest rate differential between the two currencies or securities, and (2) to capture a widening spread between the two (e.g. the expectation that one currency will appreciate against the other).
Global macro managers frequently combine carry trades with other positions to hedge risk or take advantage of momentum in exchange rates. For example, they may use a carry trade in one currency pair while taking an opposing position in another pair to create a market-neutral strategy.