When Brian Singer and Thomas Clarke worked at UBS Global Asset Management in the early 2000s, they noticed that the lines between hedge fund managers and traditional institutional portfolio managers were blurring as alternative strategies became more mainstream. At the time, Singer was helping the firm’s institutional clients implement alternative strategies as the chief investment officer for the Americas at UBS Global Asset Management. Clarke was doing the same as the firm’s head of currency analysis and strategy.


But the same trend didn’t seem to be taking hold in the mutual fund world, where traditional stock and bond long-only investing remains the industry’s bread and butter. In 2011, Singer and Clarke joined a small but growing contingent of mutual funds that take a less-traveled road, joining asset management firm William Blair to run the William Blair Macro Allocation Fund.

In Macro Allocation, which now has nearly $1.5 billion in assets, the managers make allocation decisions based on top-down, broad macroeconomic trends and the valuation measures of various asset classes. They translate their convictions through a number of strategies, one of which is to hold long and short positions in equities, fixed income and currencies. Instead of using individual securities, the fund turns to exchange-traded funds and other investments that provide broader index and currency exposure.

Singer believes that the fund’s bird’s-eye view element is more important to investment portfolios than many investors realize. “We wanted to create a fund driven by macroeconomic consideration to complement the traditional stock and bond holdings investors already have,” he says. “While most portfolios diversify among asset classes, they only take a bottom-up perspective. They have a limited amount of diversification on a top-down basis. This fund provides that macroeconomic diversification.”

Currency trading, an important part of the fund’s strategy, is an asset class and source of diversification and returns that’s missing from most portfolios, even those with international holdings. “An unhedged international fund will give you unconsidered currency exposure that happens to be tagging along with the equity markets,” Singer says. “We are introducing thoughtfulness into the process by taking advantage of mispricing opportunities around the world.” He estimates that about 40% of the fund’s returns since its launch are attributable to the currency side of the portfolio.

 

While most investors tend to trade currencies to anticipate where the exchange rate will move over short-term horizons, the fund implements a longer-term approach by taking positions based on lasting economic trends and whether the managers think a currency is overvalued or undervalued relative to others. Often, they’ll maintain those positions for months, or even years. “The common view is that you cannot invest in currencies based on longer-term fundamental considerations and that they create unnecessary volatility in a portfolio. Both are simply untrue.”

The goal is to provide equity-like returns over a five- to 10-year market cycle with less volatility than the stock market, as well as to offer a source of noncorrelated returns. While the fund’s volatility is similar to that of a typical 60/40 balanced portfolio, its correlation with the equity market tends to be lower. In terms of performance, it has been in the top 3% of funds in Morningstar’s moderate target risk category over the last three years.

Financial advisors incorporate the fund into portfolios in different ways. “Some fund the investment through allocations that would otherwise go to stocks and bonds because the fund has a high correlation to a balanced portfolio, yet its returns are more equity-like. Others see it as an addition to a diversified growth bucket, since it has a positive but low correlation to the equity market. And in a low-interest environment, investors looking to put money into something other than bonds are using the fund as a lower-risk source of diversification.”

With a macroeconomic outlook in mind, Singer points to several trends that will drive the fund’s strategy in the coming years.

Currencies: A Growing Source Of Returns
Singer suspects that in the coming years, “the greatest opportunities for the fund will come from managing currencies.” Differences in exchange rates are likely to intensify as central banks around the world pursue divergent monetary policies. China’s push to make the yuan dominant in Southeast Asia and the ascendance of emerging market countries as the engines of global growth will also create dispersion among world currencies and create opportunities for active management.

“Over the last 50 years, global growth has averaged about 3.5% and has been led by developed world economies,” he says. “We suspect that going forward global growth will be about the same, but this time emerging market economies will lead the way. That shift will almost certainly have an impact on exchange rates.”

 

To determine whether a currency is overvalued or undervalued, the managers use the economic concept “purchasing power parity,” which compares the cost of goods and services among countries when currency translation is taken into account. “The price of goods has got to be roughly the same from country to country,” says Singer. “If it is not, there is an imbalance that can be acted upon.” The fund goes short on currencies that appear overvalued and takes long positions in those that appear undervalued.


At current levels, the fund is taking a neutral stance on the U.S. dollar relative to other currencies. “Two years ago, we took the position that the dollar was cheap, but since then it has rallied strongly against the euro, yen and other currencies. The market view is that the U.S. dollar will continue to gain strength. Our view is that the dollar is fairly priced because the market has already priced in monetary policies in the U.S. and other countries.” The fund is short in other developed market currencies such as the Swiss franc, euro and Australian dollar, but it’s long on the Indian rupee and Chinese yuan.

Equities: Value Scarce In The U.S.
Over the last two years, the fund’s exposure to the U.S. stock market has dropped by two-thirds. The only sizable long position is in U.S. large-cap value stocks, and the fund is short in the large-cap growth and small and micro-cap areas. After combining the positive long and negative short positions, the fund’s exposure to U.S. stocks is close to zero.

The reduction in U.S. equity exposure began about two years ago as a result of discussions Singer and Clarke were having with global investment managers. “There was a broad perception that the U.S. equity markets were the only source of stability,” Singer says. “That was a signal to us that U.S. equity prices were going to get pushed beyond fundamental value. And that is what is happening.”

On the other hand, Europe and Asia emerging markets, two areas where concerns about economic growth are greater, offer better equity values. Because European companies do business around the world, the economic struggles of their home countries have a muted effect on their bottom lines, yet the stocks are selling at decent valuations. And because companies in Spain and Italy have been lumped together as risky southern European bets, thanks to problems in neighboring Greece, their equity values are particularly attractive.

Nonetheless, the fund has reduced its European position over the last few months because of Greece’s struggles. “The high-risk brinksmanship maneuvers with Greece will lead to a destabilization of the European equity markets,” Singer cautions. “We may increase the position once the dust settles and markets have begun to recover.”

On the other hand, the managers have increased emerging market positions significantly over the last year. China, where concerns about economic growth have kept a lid on stock prices, represents the largest position in this part of the portfolio. The fund is also long on equities in India, Russia and Korea. But there is no exposure to the Latin American markets, which Singer considers overvalued.

Fixed Income: Lots Of Red Flags
Around the world, bond yields remain artificially depressed as central banks in Europe and Japan continue to keep demand stable through bond-buying programs. While the U.S. Federal Reserve stopped buying bonds in 2014, a weak economic recovery is keeping yields artificially low.

In this environment, the fund is cautious about the fixed-income market and has negative net exposure in Germany, Japan and other countries where bond yields are in negative territory. “It’s astounding to me that in many countries you have to pay interest to lend money,” says Singer. “In that kind of environment, we are short fixed income in a number of European markets.”

Even though interest rates are low in the U.S., they are still in slightly positive territory, and the fund’s long positions in fixed income are concentrated in U.S. securities. Singer believes the Federal Reserve is likely to wait until at least December before it begins raising rates and that any increase is likely to be “slow and measured.”