Macro hedge fund stars enjoy market volatility

Rising inflation may put scarers on investors and consumers alike, but one group of traders is taking full advantage.

Global macro hedge funds, made famous by the likes of George Soros and Louis Bacon, are enjoying their biggest gains in years as inflation opens up some of their favorite deals in the bond and commodity markets.

A senior executive at one of the world’s largest hedge funds said overall trading this year is “great,” highlighting the opportunities offered by inflation and bond market moves.

Some managers have done “exceptionally well in areas such as commodity and trend [interest] Interest rates trade in response to changing inflation dynamics,” says Aurum Research.

Market moves this year have been particularly favorable for macroeconomic funds seeking strong trends. The yield on the rate-sensitive two-year Treasury rose from 0.7 per cent to 3.1 per cent, as central banks race to try to tame unbridled consumer price growth.

Another attractive trade bet is the near-constant narrowing of the gap between US 2-year and 10-year bond yields. The US yield curve is already inverted with short-term interest rates rising above longer-term rates. Sharp fluctuations in commodity prices were also profitable bets for many.

Among the winners is Ray Dalio’s Bridgewater Pure Alpha, which made 21.5 percent this year through the end of July, helping bets that policymakers and markets will eventually have to respond to rising inflation pressures and tightening monetary conditions. The Macro Fund managed by Caxton CEO Andrew Low, who predicted at the end of 2020 a “significant deflation”, also posted a profit of 24.9 percent, buoyed by bets on stagflation.

Total funds rose on average 8.5 percent in the first half of the year, according to the HFR dataset. This summer, Kenneth Tropin, founder of $18 billion Graham Capital, told the Financial Times he “couldn’t remember a more interesting time to be a macro investor since the financial crisis.”

Market moves have resulted in some of the most exciting returns of the year. Crispin Ode, long a lone prophet of high inflation, which has suffered a string of losses in recent years, has made a gain of about 115 per cent in its European fund this year. The New York-based Hyder Capital Fund rose by about 170 percent.

The gains stand in stark contrast to the broader hedge fund industry, many of which are having a year to forget. Hedge funds are down 5.6 percent on average, according to HFR, with equity-focused funds particularly hard hit. Many managers found themselves owning too many expensive tech stocks that had been hit by rising interest rates, offering little in the way of hedging to investors.

Unlike many of their stock fund peers, macro managers do not rely on emerging markets for their earnings. Instead, they look for fluctuations in bonds, currencies, and other markets.

For most of the past decade, that proved elusive as central bank stimulus curbed market volatility and crushed their preferred trades. Bets that bond yields will rise from extremely low levels often fail.

But last fall marked a turning point. Markets are suddenly starting to worry that the central bank’s narrative of raising interest rates too slowly cannot be trusted after all. Some funds, most notably Chris Rokos’ Rokos Capital, have been grounded as bond market volatility returns.

Some managers are now warning that the market is too optimistic about the Fed’s ability to tame inflation quickly, pointing to the yield curve inversion in the US as a harbinger of troubled times ahead. Usually, investors seek higher returns to compensate for the risk of holding bonds for a longer period. An inversion of the yield curve is a sign that investors expect higher interest rates to trigger an economic contraction that will eventually ease monetary policy.

Decio Nascimento, chief investment officer of hedge fund firm Norbury Partners, which is up about 7 per cent this year, says market confidence in the speed at which US inflation will fall to 2 per cent is “preposterous” compared to historical precedent.

Meanwhile, Audi expects the “firm market belief” that the Federal Reserve has done enough to control inflation will erode this fall. As markets adjust, big sell-offs in conventional government bonds and big gains in index-linked bonds are expected, according to an investor letter seen by the Financial Times.

If managers like Odey are right, investors and consumers may have to get used to high inflation for some time now. But for macro funds, trading opportunities may be just getting started.

laurence.fletcher@ft.com