Q&A: Neil Azous Talks Global Macro Investing

Nov 24 2014 | 1:41pm ET

Neil Azous is the founder and managing member of Rareview Macro, an advisory firm to some of the world’s most influential investors and the publisher of the daily newsletter Sight Beyond Sight. Azous recently sat down with FINalternatives to speak about his latest views on global macro investing.

FINalternatives: On September 4, 2014, in an article titled The Cult of Loss Aversion: A Call to Rethink Risk in Global Macro Investing, you argued that “the call right now should be to re-think how investors look at risk and that investors should demand from their managers a return to old-school macro investing, where themes are given time to play out, portfolio turnover is significantly reduced, and more focus is placed on absolute returns at the expense of fetishizing drawdown limitation.”

The year appears to be concluding where it started for macro investors, generally disappointing. Take us back to the beginning and tell us what’s gone wrong?

Azous: Most macro investors struggled out of the gate in January as the U.S. dollar, equities, and yields all declined. These trades were left over from profitable positions in December 2013 and reversed sharply on the first trading day of the year. Pension rebalancing was an obvious culprit for driving the equities lower/bonds higher price action, which was then amplified as macro investors exited their positions.  Although U.S. and Japanese equities have subsequently rebounded and climbed to new highs, on a global basis stock market performance has been much less impressive. Moreover, trying to position for an incipient tightening cycle in the U.S. has proven extraordinarily challenging, as neither yields nor volatility have moved in accordance with most macro managers’ expectations. While the dollar trade has generally come good, there have been a couple of gut-wrenching pullbacks that forced many managers to stop out of what would otherwise have been profitable positions.

Shouldn’t macro managers have anticipated the pension rebalancing?

The most successful macro trades tend to follow underlying price momentum as investors “let their winners run”. The long equity/short bond trade had been a successful one in 2013, and while some investors may have trimmed their positions going into the year-end, discipline mandated keeping some exposure to the theme. What proved problematic for macro investors is that aggressive rebalancing flows hit the market literally on the first trading day of the year. While it became clear after a few days that the theme of pension rebalancing was more than just mere noise, by that point many investors were already in a hole and the best they could do then was try to limit the damage.

You mentioned that macro investors stopped out of their long U.S. dollar positions on pullbacks. Is this a case of over-trading?

As I argued in my previous article, many macro funds have become devotees of what I call the “Cult of Loss Aversion.” In this framework, managers attempt to maximize the probability of positive return of a given trade or portfolio, rather than maximizing the expected return (i.e., probability of positive return multiplied by the magnitude of positive return). In this context, avoiding drawdown bogeys becomes the paramount consideration for portfolio managers, leading them to take many quick losses on themes rather than giving them what some might consider a more appropriate amount of rope. The dollar trade is a prime example of this.

Macro performance has been generally poor over the past several years, particularly in comparison with simple benchmarks like the S&P 500. Has the edge vanished from global macro investing?

Generally speaking, what gives you an edge in macro is an accurate analysis of the economic cycle, correct forecasts of relevant policy responses, and a shrewd anticipation of the capital flows that will result from that. That there has been relatively little tradable policy response from major central banks over the past few years is a major reason why macro has struggled, so indeed one could argue that during this period there has been little discernible edge in macro. It is probably not a coincidence that a number of high-profile investors have exited the fund-management industry since 2011. That said, the Fed is lumbering towards tightening policy for the first time in nearly a decade. That should provide the sort of tradable policy dynamism that typically provides global macro with an edge, particularly in the context of the ‘low-vol’ asset inflation that has characterized the past several years.

Why does risk appetite amongst macro traders appear to be so low?

Imagine you’re sitting at a blackjack table with the worst hand you’ve ever seen. Would you bet large or small in that context? The utilization of risk is a function of perceived opportunity, not a monolith where every trade is sized identically regardless of quality. Without the tailwind of a solid P & L cushion over each of the past several years, it has been difficult for many if not most macro traders to be enthused about ‘getting out the club,’ especially when the message from their management and their investors is ‘just don’t lose money.’

In creating a macro portfolio management team, is it better to assemble a team of specialists that focus on one particular market or asset class, or to gather a set of generalists that will trade anything?

Each of these approaches has its own strengths and weaknesses.

Specialists are clearly able to harvest more alpha out of their specific markets than generalists, which is a positive. However, there is also the risk of specialists forcing trades in their markets when in fact there is little opportunity, because that’s the only way they can try to make money. Moreover, while the overall portfolio produced by a team of specialists may benefit from diversification, by the same token it can often lack the underlying thematic quality that has characterized the most compelling macro success stories.  

Generalists, meanwhile, are afforded the opportunity to deploy risk where they see fit, which allows them to craft a thematic portfolio and to avoid bad markets. However, there is a risk of being spread too thin and missing either an opportunity or a risk that a specialist could more easily identify. Thematic portfolios also typically incur correlation risk, which can be difficult to manage in real time.

The ideal model is probably a hybrid of the two approaches. Sufficient cross-pollination between specialist and generalist PMs and analysts should allow each to retain their relative strengths while at least mitigating the weaknesses of each approach. But that does depend critically on having the right team.

What do you think distinguishes the top performing macro strategists from the pack?

The best strategists are those that are able to accurately and successfully analyze every link in the chain, from the economic outlook to policy reaction to market response. They typically do this by looking at things from a different viewpoint from the rest of the market; this can be very in-depth, almost equity-style analysis of a specific trade in a specific market, or a view from 40,000 feet that links a number of factors into a broad but powerful theme. Those who own the view through thick and thin also tend to establish more credibility than others who only discuss successful calls.

What is your approach to owning views and maximizing credibility?

We think it is very important to be accountable and transparent with our audience. That is why Rareview Macro runs a hypothetical model portfolio of investment strategies and tactical trades, which are published in real-time on Twitter and discussed daily in Sight Beyond Sight. While a paper portfolio does not necessarily face the same pressures as professional money managers, it nevertheless provides evidence of a robust investment and thought process and allows readers to track the quality of my ideas. That the portfolio has outperformed the traditional macro benchmarks the last two years by a large margin hopefully provides some firm evidence of the quality of my analysis that I am doing.

What do you see as the primary drivers that will impact markets the most during the next 6-months?

The most important is likely to be the market coming to grips with the timing of the first Fed rate hike. When it comes, no one under the age of 30 will have seen a Fed hike in their professional lives, which could add to the increase in volatility that typically accompanies tightening cycles. Additionally, the possibility of real divergence in global policy cycles for the first time in a decade should open up a number of interesting cross-market opportunities. At the same time, however, the perceived developing threat of deflation is likely to drive the decisions of many policymakers, potentially including those at the Fed if U.S. growth falters. Ironically, of course, the collapse in oil prices should provide a welcome tailwind to consumer spending! In contrast to this year’s counter-intuitive lack of dispersion, where being long a stock index is the alpha and short single stock securities is the beta, the environment should normalize and return to single stock selection as a key driver of decision making and alpha generation. The Swiss Franc (CHF), a barometer for safety, faces its own problems right now, and market expectations are growing that Switzerland will be next to face a crunch point. The Japan theme has gotten a new lease on life over the past several weeks, and there is certainly the risk of at least a short-term parabolic move in the Nikkei and Yen.

Ultimately, are you a buyer or a seller of global macro as an industry?

Given the current dissatisfaction with the industry after years of poor performance, I think you have to be a buyer on an improved outlook as policy conditions in the U.S. begin to normalize. That having been said, the industry has probably done itself a disservice by focusing on increasingly short-time horizons in the pursuit of ‘loss avoidance.’ It would be much easier to be constructive on the outlook for the industry if investors and management removed some of the shackles from talented portfolio managers. I’ll become more upbeat when I see people trading their own genuine convictions rather than just their P & L’s.

Neil Azous is the Founder and Managing Member of Rareview Macro, an advisory firm to some of the world’s most influential investors and the publisher of the daily newsletter Sight Beyond Sight. Neil has close on two decades of experience across the financial markets, and is recognized as a thought leader in global macro investing. Prior to founding Rareview Macro, Neil was a Managing Director at Navigate Advisors where he specialized in constructing portfolios and advising on risk.  On Wall Street, his career included roles at UBS Investment Bank and Donaldson Lufkin & Jenrette, where his responsibilities comprised of trading derivatives, hedging solutions, asset allocation and fundamental securities analysis. He began his career at Goldman Sachs in Fixed Income.

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