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Macro funds for inflation and interest rate threats

Macro funds could help to mitigate the effects of inflation and interest rate rises on your portfolio
November 11, 2021
  • With the threat of inflation and interest rate rises, macro funds could be useful
  • These funds tend to be able to invest in a variety of assets and may be able to take short positions
  • Macro investing can be notoriously difficult, so you should carefully assess these funds before investing in them

Equity fund managers commonly insist that they focus purely on 'bottom-up' stock picking – choosing holdings on the basis of their individual merits rather than macroeconomic factors. But some macro factors may now seem too great to ignore. Inflation has been one of the biggest talking points of the year, with expectations on rising prices and the direction of monetary policy already causing havoc for the bond market. Such developments have become the subject of great speculation, from future levels of inflation to when and how far central bankers will raise rates in the future.

So it could be worth incorporating a macro-oriented approach into portfolios. While bottom-up investing has worked extremely well for some of the best equity managers, funds with an explicit macro outlook can be a way to specifically focus on economic trends. In today’s context they may have some appeal – provided they work.

 

Where might a macro mindset be useful?

While some stock pickers keep an eye on external factors when assessing the outlook for potential holdings, many macro funds tend to operate across different asset classes. They often take either a multi-asset approach or focus on bonds. Such funds tend to have a wide range of tools at their disposal, from the variety of assets they can hold to an ability to take short positions – bet on prices falling.

Given the threat of both inflation and rising rates, fixed income may be an area where investors might appreciate a macro-oriented approach. As Darius McDermott, managing director at FundCalibre, puts it: “If people have to own some fixed income, in a rate rising environment it makes sense to have something that can actually short these things and take positions on a macro standpoint.”

Some well-established fixed income teams run macro-oriented funds. McDermott and Rob Burdett, co-head of the multi-manager people team at BMO, favour M&G Global Macro Bond (GB00B78PH601), managed by Jim Leaviss and his team.

While many flexible bond fund managers tend to either ramp up the risk they take in the hunt for higher yields or attempt to offer diversifiers against equity market volatility, this fund's managers instead focus on broad total returns. But M&G Global Macro Bond's approach and flexibility may still appeal.

This fund had a spread of different investments at the end of September, with over half of its assets in government bonds. It also had 16.2 per cent and 10.7 per cent net exposure to investment grade corporate bonds and emerging market debt, respectively. The fund’s literature states that its investment approach allows for “extensive use” of derivatives, enabling it to take short positions. At the end of September, its biggest net short exposures were high-yield corporate bonds, and credit default swaps and indices. The fund's investment team tends to combine in-depth analysis of individual bond issuers with an assessment of global, regional and country specific macroeconomic factors when investing.

Other specialist teams run macro bond funds including Vontobel TwentyFour Absolute Return Credit (LU1368730674). As is often the case with flexible funds run by TwentyFour Asset Management, it makes use of specialist fixed income securities, differentiating it from many conventional bond funds. This fund had around 40 per cent of its assets in financial debt at the end of September, with smaller allocations to corporate bonds, government debt, asset-backed securities and hybrid bonds.

Artemis Target Return Bond (GB00BJXPPJ80) also had heavy exposure to financial debt and a good weighting to UK bonds. Allianz Strategic Bond (GB00B06T9362), meanwhile, was predominantly invested in government bonds at the end of September. But this fund still makes big trades on the direction of different bond markets and currencies using derivatives. It had an exceptionally strong 2020 after taking short positions on credit markets before buying in on the back of the sell-off that spring.

A number of multi-asset funds also make macro calls. These include investment trusts such as BH Macro (BHMG) and Pershing Square (PSH), and many Investment Association (IA) Targeted Absolute Return sector funds. With bonds and gold looking threatened, there’s a case for holding such funds as a potential portfolio diversifier. "Some of these funds can be quite uncorrelated," notes McDermott.

 

Do they work?

However, macro funds' track records have been mixed. Macro investing can be notoriously difficult: funds that find themselves on the wrong side of a trade can suffer hefty losses. Even when macro managers correctly forecast events, markets can react to developments differently to how they expected.

This is one reason to very carefully assess funds like these and potentially limit the size of your position in them. It is very important to consider what kind of scenario a manager is preparing for and how they have positioned their fund. Earlier this year, we looked at how the biggest strategic bond fund managers viewed the prospect of inflation (How bond funds are facing the inflation threat, IC, 06.08.21). While some such as Allianz Strategic Bond's manager Mike Riddell viewed as it as transitory others remained wary.

 

 

As always, carefully assessing performance in different market conditions can be telling. For example, the chart shows how some macro funds fared versus global equity markets and the average UK gilt fund, in calendar year 2020 and the first 10 months of 2021. While relatively simplistic, it shows how such funds can generate fantastic returns when they are correctly positioned. BH Macro, Pershing Square and Allianz Strategic Bond made especially strong returns in 2020.

This year has been much more difficult for non-equity approaches and funds with big exposure to government bonds have had an especially tough time. This can prove painful for funds that have deviated from the market such as Allianz Strategic Bond.

Some funds take a slow-and-steady approach, and have at least managed to limit the pain suffered in the conventional bond market. Examples include M&G Global Macro Bond and SVS Church House Tenax Absolute Return Strategies (GB00BNBNRF27), a relatively cautious multi-asset fund favoured by McDermott. It had a substantial allocation to floating rate notes in late October and a big weighting to conventional bonds. Both funds have fared better than the average gilt fund this year, although M&G Global Macro Bond has still made a negative return.