Using The Whole Field

It was August 1992 when George Soros saw a rare currency trade align.

A dozen years earlier, the European Economic Community (forerunner of the European Union) introduced the Exchange Rate Mechanism, which was designed to keep continental currencies within a trading range of one another. When spreads between targeted and actual exchange rates strained currency links, ERM coordinated multi-central bank intervention—purchasing weaker currencies and selling stronger currencies to sustain exchange rates.

Speculators, who thought such links couldn’t be maintained, periodically tested such exchange-rate coordination. They knew interest rates were still the charge of individual central banks, whose agenda included economic growth—a goal often at odds with supporting a currency’s value.

Soros believed the British pound had entered ERM overvalued versus core European currencies. To maintain this link, Britain had to push up interest rates to drive demand for the pound. Yet the rising cost of borrowing was a drag on the country’s already stagnant economy.

Soros thought this imbalance could not stand and aggressively shorted the pound. The German Bundesbank, the standard-bearer of continental currency policy, grudgingly conceded the futility of supporting the currency and, by September 1992, Britain allowed its currency to float. The pound sank, and Soros was a billion dollars richer.

Classic Macro
Soros’s sterling gambit was a classic global macro play, revealing a compelling side of the strategy: a go-anywhere investment approach, unrestricted in terms of geography, asset class or currency preference, that focuses on broad financial market behavior.

One may think this approach should make it easier to recognize a good investment than finding the next hot stock. But it doesn’t. Managers are lucky to get their bets right half the time.

Decades ago, global macro investing was more akin to big-game hunting, the domain of affluent individual investors who predominated in the hedge fund space. But just a few years after Soros’s coup, macro managers got socked by unexpected interest rate increases, the sequential collapse of emerging markets around the globe and the fallout from the sudden demise of Long-Term Capital Management. Massive government market intervention after the financial crisis further muddied the strategy.

Investors poured out of the space, and today it represents only 6% of all hedge fund assets.

Global macro funds were forced to recast themselves in the 21st century “as more measured managers than their swashbuckling forebears...relying on less leverage and more care, using derivatives, risk controls and other innovations to construct asymmetric positions that limit losses,” says Matthew Ridley, a hedge fund manager and industry consultant.

As the predominance of hedge fund investors has shifted from family offices and high-net-worth individuals to institutional investors, who now account for more than two-thirds of hedge fund assets, greater emphasis is now placed on more conservative management that seeks steadier, less volatile returns.

Today’s macro managers bet on the movement in various stock indices, interest rates, commodities and foreign exchange rates, using cash and derivatives to gain straight and leveraged exposure. Some managers are trend followers, while others may seem to be contrarian investors trying to position early into a rally or fall.

They can coordinate trades, anticipating short-term U.S. bond prices may fall as interest rates rise, while betting higher rates will strengthen the dollar versus the euro.

Or they may hedge investments. In taking a long position in copper, expecting the metal to rally, managers might short stocks in Chile (a leading producer of copper, to which its economy is geared) in case the price of the metal falls.

Because global macro funds typically make hundreds of short-term trades a year, they usually don’t swing for the fences, typically looking instead to collect lots of singles. At the same time, they will quickly exit trades when prices move against them. This tends to produce range-bound returns, especially relative to stocks.