Why Have Global Macro Hedge Funds Underperformed?

By Martin T., Macronomics

“There is no better than adversity. Every defeat, every heartbreak, every loss, contains its own seed, its own lesson on how to improve your performance the next time.” – Malcolm X

Many pundits have recently looked at the lackluster performances of Hedge Funds from the European crisis perspective. We would like to have a different approach, namely the one of volatilities.

Courtesy of our good friends at Rcube Global Macro Research, the answer appears to be simpler. It’s the volatility stupid! Or lack thereof….

“Volatility across all asset classes has crashed. As the chart below highlights, when this happens, global macro strategies tend to suffer on both an absolute and relative basis.”

“While investors have poured massive amounts in long equity volatility products over the last 9 months, as a hedge against long stocks exposure, this strategy failed spectacularly. We believe more pain lies ahead for long equity volatility trades.”

We would like to highlight an interesting pattern in VIX futures, illustrated by the following kernel regression analysis between these variables:

X: the sum of 100 days Z-Score of the S and P500 Index and the SPVXSTR Index (a rolling long VIX strategy, tracked by the VXX ETF).

Y: Annualized expected returns of the SPVXSTR Index.

We see that when we are at the low end of the range (meaning that volatility does not react to a market dip, which is currently the case), further weakness should be expected on vol forwards.

Regarding other measures of sentiment/positioning, investors still seem to be extremely defensive while stock markets have rallied substantially over the last few months. This remains the most hated bull market in recent history.

Classic measures of sentiment are still deeply negative and at levels that are usually reached after medium to long term bear markets.

The CBOE put/call ratio reached historical highs on both the 10 and 90 days sma last week:

Stocks have very substantially lagged credit this year. We have advertised in recent publications why we believe corporate credit outperformance is over.

The recent sharp improvement in US consumer sentiment doesn’t seem to have been priced by the stock to bond ratio.

We are also aware that earnings revisions have been on the weak side recently.

In addition to the great points made by our good friends from Rcube, with interest rates at zero it is as well very challenging for Global Macro Hedge Funds to play an economy against another in currencies markets due to the fall in volatilities.

To bring some solace to Global Macro Hedge Funds, their biggest liquidity and volatility providers, namely top investment banks, are suffering as well, as reported by Neal Amstrong article in Bloomberg – Biggest Traders Hurt as Fed to ECB Crush Volatility – on the 23rd of November:

“The world’s largest currency traders say foreign-exchange revenue is sliding as central-bank policies stifle price swings and cut volumes by $300 billion a day. Deutsche Bank AG, the biggest dealer based on Euromoney Institutional Investor Plc data, says narrower margins cut revenue “significantly” last quarter. Barclays Plc, the third-largest, says foreign-exchange sales are dropping and fourth-placed UBS AG says it has been hurt by lower volatility. Daily turnover as measured by CLS Bank, operator of the largest currency-transaction settlement system, slid 6 percent to $4.72 trillion in the third quarter from the year-earlier period. The combination of interest rates at, or near, record lows in the U.S., Europe and Japan is diminishing the allure of the dollar, euro and yen, the three most-traded currencies. From Switzerland to Brazil, central banks are establishing controls on exchange rates, making it less lucrative to trade the franc to the real. “With interest rates being at zero it’s very difficult now to play the cyclical differences in economies,” David Bloom, global head of currency-market strategy at HSBC Holdings Plc in London, said in a telephone interview on Nov. 20. “We’re in a structural world where if you have an economic event, you are best placed to think about it in terms of equities or bonds rather than foreign exchange.”

“Past performance speaks a tremendous amount about one’s ability and likelihood for success.” – Mark Spitz


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Martin T., Macronomics

Martin T. is a credit specialist with a London based bank. During his career he's had different roles within various banks, covering everything from FX to High Grade Bonds. He has always been passionate about markets and particularly on Macro trends.

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  • InvestorX

    Interesting comments, especially the first two charts.

  • Tom Hogshead PhD

    About “We believe more pain lies ahead for long equity volatility trades,” if anyone is interested knowing how and when VIX volatility will change, Volatility Research accidently stumbled onto a pretty good way to predict VIX “fear guage” volatility using NYSE VXX:


    The klinker in this market-woodpile is VIX volatility, and this 11-month rally may prove to have been a house-of-cards.

    We’re in the lull before the Perfect Volatility Storm.

  • whatisgoingon

    I’m not sure if I understand the dynamics exactly but I will say that I have some Silver Leaps I purchased earlier this year when silver was under $30 and since then silver has rallied over 15%. Yet the leaps are break-even because the market maker decided to price Leaps with a very high vega all the while the Gold Vix (GVZ) is making lower lows.

    I looked at Spy Leaps and the same situation exists (high historic vega and low Vix) which means the implied volatility of the leap option are very low. And I suspect anyone who purchased Spy leaps are under water. Now whether hedge funds are seeing their returns being eroded away by declining risk premium on options I don’t know. But I’m just speculating and probably venting too.

  • Jason Emeott

    Interesting, insightful article. Question on the kernel regression analysis – I’m not following the significance / how it’s calculated. Any background on this?

    Many thanks,