2.2 Macro and managed futures

Most people's picture of investing is buying shares in companies. Global macro and managed futures funds work differently. They rarely focus on individual companies. Instead they take positions on whole markets: interest rates, currencies, commodities and stock indices, often on both sides and across many countries at once.

These strategies matter to allocators because they can behave differently from stock and bond portfolios, which is one reason investors add them. They matter to operations and administration staff because they trade mainly derivatives, such as futures and forwards, which bring their own margin, collateral and valuation work. This lesson explains what each strategy does and why its results can diverge from the stock market.

Global macro

Global macro funds take positions based on views about the economy and policy. A manager studies things like growth, inflation, central bank decisions, government borrowing and politics, and asks how they will move prices in major markets. Typical positions include:

• Interest rates: for example, buying government bond futures if the manager expects rates to fall, since bond prices tend to rise when rates fall.
• Currencies: for example, selling a currency the manager expects to weaken against others.
• Commodities: for example, buying oil futures if the manager expects supply to tighten.
• Equity indices: for example, buying or shorting futures on a country's main stock index, rather than picking individual shares.

Positions are commonly held through derivatives: contracts whose value depends on another asset. The main ones are:

• Futures: standardized contracts, traded on an exchange, to buy or sell an asset at a set price on a future date.
• Forwards: similar agreements made privately between two parties, widely used for currencies.
• Options: contracts that give the right, but not the obligation, to buy or sell at a set price. They let a manager limit the loss on a view to the price paid for the option.

Derivatives let a fund take large positions while putting up only a fraction of their value as margin (collateral). That makes them efficient, but it is also a form of leverage, covered in Lesson 3.2.

The following example is illustrative. Tidewater Point Capital, a fictional macro manager, believes inflation in one country is cooling faster than markets expect and that its central bank will cut rates. The manager might buy that country's government bond futures, sell its currency through forwards (on the view that lower rates may make it less attractive to hold), and buy options on its stock index as a cheaper, limited-loss way to benefit if lower rates lift share prices. If the view is wrong, all three positions may lose together, so position sizes and stop-loss rules matter.

Most macro funds are discretionary: people make the decisions, using their judgment and research. Some are systematic, using models to generate trades. Macro portfolios can change quickly. A fund might be positioned for rising rates one quarter and falling rates the next.

Managed futures and CTAs

Managed futures funds trade futures, and often currency forwards, across a wide range of markets. Their managers are often called CTAs, short for commodity trading advisors, a label that comes from US futures regulation. Despite the name, most trade far more than commodities: stock index, bond, interest rate and currency futures are commonly part of the mix.

Most managed futures programs are systematic. Computer-based rules decide what to buy and sell, how much, and when to exit, with people designing and monitoring the rules rather than choosing each trade.

The most common approach is trend following:

• If a market has been rising over a chosen period, the rules buy it (go long).
• If a market has been falling, the rules sell it (go short).
• When a trend fades or reverses, the rules cut or flip the position.

A trend follower doesn't need to know why a market is moving. It aims to capture a share of large, sustained moves in either direction, and to accept many small losses when trends fail to appear. Programs commonly trade dozens of markets, so a few strong trends can pay for many small losses elsewhere.

Positions are usually sized by volatility, meaning how much a market's price typically moves. A calm market gets a larger position and a jumpy one a smaller position, so each market contributes a similar amount of risk.

Some managed futures funds use other systematic signals too, such as relative value between markets or the cost of carrying a futures position, but trend following remains the core of many programs.

Comparing the two

Why they can behave differently from stocks

Most investors' portfolios rise and fall largely with stock markets. Macro and managed futures funds can behave differently, for three main reasons.

• They can be long or short. Neither strategy has to own stocks. It can be short equity indices, long government bonds, or have no equity position at all.
• They trade many asset classes. A fund's result may depend more on currencies, rates or commodities than on stocks.
• Trend following adapts. In a long, steady market decline, trend-following rules may turn short equity futures and long bonds as the falls continue.

For these reasons, managed futures have sometimes produced gains during long stock market sell-offs, and some macro managers have profited from positioning ahead of crises. Allocators often describe this as potential diversification or crisis protection.

This behavior is not guaranteed. A sudden crash that reverses quickly can catch trend followers on the wrong side before their rules adjust. Choppy markets without clear trends can produce long stretches of small losses. A macro manager whose view is wrong can lose money in a crisis like anyone else. Results also vary widely between managers, so one fund's past crisis behavior says little about another's.

Key terms

• Global macro: a strategy that takes positions on interest rates, currencies, commodities and equity indices based on economic and policy views.
• Managed futures: a strategy that trades futures across many markets, commonly using systematic rules.
• CTA (commodity trading advisor): a manager of managed futures, named after a US futures regulatory category.
• Futures: exchange-traded contracts to buy or sell an asset at a set price on a future date.
• Forward: a privately agreed contract to buy or sell an asset, often a currency, at a set price on a future date.
• Option: a contract giving the right, but not the obligation, to buy or sell at a set price.
• Trend following: buying markets that have been rising and selling those that have been falling.
• Systematic: trading driven by pre-set rules and models rather than case-by-case judgment.

Key takeaways

• Global macro funds trade views on rates, currencies, commodities and equity indices, commonly through futures, forwards and options.
• Most macro funds are discretionary; most managed futures funds are systematic, and many follow trends.
• CTAs commonly trade futures across many markets and size positions by volatility.
• Because they can go long or short across asset classes, these strategies can behave differently from stocks, and have sometimes gained in prolonged sell-offs.
• Crisis protection is not guaranteed: sharp reversals, trendless markets and wrong views all cause losses.