Category Archives: Diversification

Active Beta

Active Beta is a term that is not often heard but the concept is often discussed. In this post at The Macro Trader They discuss how they are implementing the concept of relatively passive, risk controlled, capturing of risk premia.

If you are searching for alpha the post is worth reading, as is the newsletter.

-Trade Macro

Morgan Stanley Buys >20% of Barton Biggs Traxis Partners

Morgan Stanley has purchased a less than 20% stake in Traxis Partners. The Macro hedge fund started by Barton Biggs. This follows Morgan Stanley purchases of Avenue Capital, Front Point Partners, and Lansdowne partners in the past year. They are trying to buy their way into the hedge fund space and so far it is working all right.

This purchase was near and dear to Morgan because Biggs used to be the chief market strategist at Morgan before claiming that Hedge Funds were in a bubble and then leaving to start one. Traxis has about $1.5 billion under management and has done decent since inception. A few years ago Barton Biggs also wrote the book Hedge Hogging.

-Trade Macro-

Iluka Up 10% On Ospraie Purchase

Ospraie Management the macro fund ran by Tiger Alumni Dwight Anderson purchased 12% of the Australian mineral sands miner Iluka. Wednesday on news of the purchase the stock was up 10% in the Australian market.

Ospraie Management is one of the premier Macro Commodity funds out there. They invest in many things but focus primarily on hard assets and companies that deal in hard assets such as metals, oil, etc. They have reportedly returned about 22% anually since inception with this year being one of their few underpreforming years.

-Trade Macro-

Pension Plans Intend On Investing More In Emerging Markets

GlobalPensions.com says that many pension plans are planning on raising their allocations to Emerging Markets. Most of the reasoning given is that they have been pleased that the current credit crunch in the United States has not had a very strong effect on the emerging markets.

We think that they are mostly right. Being globally diversified is typically a good thing but their reasoning is a bit weak. In a short country specific credit crunch global diversity is a great thing but don’t fool yourselves. If the current crunch (todays market rally notwithstanding) is prolonged it will effect global markets as well. Especially the rapidly growing emerging markets companies that need financing to continue their growth.

Long-global diversification
Short-weak reasoning

-Trade Macro-

One Way To Enter And Exit Asset Classes With Models

Many people have the misguided impression that anyone that market times is either 100% in or 100% out of a market. Anyone that has successfully used multiple models knows that’s simply not the case. A long time ago we read an article interviewing Marty Zweig where he discussed that while he used timing extensively he was rarely 100% in or out. Since reading that we have found that it was excellent advice and have incorporated it into our trading.

As stated previously The Macro Trader uses multiple models for virtually every asset class. For instance in precious metals we currently run five models. Three are virtually 100% mechanical one is 75% mechanical and one is discretionary in order to build up a core position. So how do we position size this? Actually it’s pretty simple. We take our allocation to precious metals and divide it by the number of trading models, in this case five. So if for instance we have allocated $100K to metals each strategy gets $20K.

Why do we do this? Primarily for two reasons. We don’t know everything and we want to earn at least some of the risk premia built into each asset class. So unless we are extremely bearish one asset class and net short we will almost always have at least some money in play there. What about leverage you ask? Well we have rules built for that as well. Our use of leverage deserves a few of it’s own posts but basically if we are extremely bullish we will usually use options in order to lever up. Depending on the situation we might use futures for an asset class or margin in stocks but usually we like options to add leverage because we can usually control our risk better.

There are several other ways to use models such as ranking each strategy and putting X% in the top one, less % in the next, etc. We will cover more ways to position size each model in future posts but for the most part we have found that while you can make this as complicated (not to be confused with sophisticated) or as simple as you want many times simple works best.

Happy Trading,
The Macro Trader

Some of the Advantages of Multiple Strategies

Many individual traders whether they are institutional or retail focus and specialize in one strategy in one market. While that is fine for part of your money if done right there are many advantages to running multiple strategies inside of your portfolio. Among them are a more consistent steady stream of returns, lower drawdowns, and the ability to perform in all market environments.

How do you achieve all of this? Well you have to go out and find successful strategies. You then have to check their correlation to each other. Depending upon the size of your portfolio you can definitely have overlap but the overall goal is to have several uncorrelated strategies. You want managers in different areas trading different ways. One manger that is involved with growth stocks, one in value stocks, another that is a trend following CTA (commodity trading advisor), another that does statistical arbitrage, a bond manager, an emerging markets manager, etc. You get the idea. As I said earlier some overlap is fine. In fact if you have large portfolio it is good to have a bit of overlap. If you can get multiple growth stock managers that trade slightly differently you will have added a bit more diversification to your returns albeit usually only a small amount. It also makes it so if one starts to under-perform you aren’t as dependent on them to extract the strategies alpha.

This obviously isn’t everything there is to generating good returns in good and bad times but is an often overlooked part of the puzzle. I can’t begin to count the times that I have talked to someone who was diversified into 10 different mutual funds by a financial advisor only to find they were barely diversified at all. Look to different strategies in different markets or to managers that trade in different markets and strategies and you will see that your returns become steadier and usually go up over time.

-The Macro Trader

P.S. In case you didn’t know most managers that trade in multiple strategies across multiple markets are Global Macro Funds or Multi Strategy Funds.

Real Diversification Part-1

It is said that diversification is the only free lunch in regards to investments.  While that may very well be the case, done the traditional way it is one of many ways to not be able to pay for your next lunch.

 If you go to most financial planners or stockbrokers they will tell you things like be 60% in stocks and 40% in bonds.  Or maybe X% in Large Caps, X% in Small Caps, X% in Treasuries, and X% in Corporate.  Sounds great right?  Along with this “diversified portfolio” you get the whole pitch that some of these will zig while the others zag so being in these separate asset classes smoothes out your returns so that you never have a drastic loss.

 Do you see a problem with any of this so far?  The problem is not that diversification can be a wonderful tool.  The problem is that just because you are in a bunch of different funds you aren’t necessarily diversified.  Take the above example: two classes of stocks and two classes of bonds.  If you actually look at what drives those asset classes you will find that over time you don’t really have four positions you have two.  Interest rates drive bond returns for the most part regardless of if they are corporates or treasuries.  What drives stocks?  Interest rates and corporate earnings.   

 I already hear some of you saying “well in the last crash Large Caps went down while Small Caps went up.”  Yes, this time that is what happened but over the long haul this doesn’t hold up.  In fact since 1995 the returns between the SP500 and SP600 had an 80% correlation.  And while the SP600 has definitely outperformed guess when it got hardest hit……..yep 1998, 2002, and summer of 2006 the same times as the SP500.  So when you needed it most the diversification fell apart.

 So how do you properly diversify?  Invest in multiple strategies in multiple asset classes.  For instance instead of just domestic stocks and bonds you could add commodities (energy, metals, agriculture, etc.), global stocks (both developed and emerging markets), global bonds (again developed and emerging markets), and real estate (same thing developed and emerging markets), hedge funds, private equity, venture capital, currency trading, and possibly even collectibles like art.  Obviously some of these have minimum net-worth requirements but the point is to invest in as many disparate and risky asset classes that you can. 

 Why diversify so much?  Because that is the only way to achieve true diversification in a portfolio.  Stocks zig a little differently from bonds which zag differently from commodities which zig differently from global stocks etc. 

 Obviously this is not all there is to it but it is a lot better then the traditional 60/40 stock bond mix.  In Part Two we will discuss how to decide what types of strategies to look for.  And in Part Three we will discuss different ways to decide how to weight your investments in each asset class.

 Happy Trading,

The Macro Trader