Systematic Global Macro Absolute Return Strategy

For RIAs: The What and Why of the Strategy

There is no lack of alternative investments since their advent in the early 1980’s. For RIAs they provide a unique opportunity to diversify what they offer to their clients and can create an overall better portfolio solution. In this report, we want to delve into a strategy which is timely due to the current unpredictability of the markets. We asked Ridgedale Advisors LP, an alternative asset management firm focused on systematic global macro absolute return and commodity specific strategies, to walk us through the strategy and why investors should consider investing in absolute return strategies.



KEY TAKEAWAYS


1. The normalization of volatility is here to stay

2. Investors need to diversify to strategies that can provide uncorrelated returns

3. Benefits of an absolute return strategy

  • Positive stable performance that is uncorrelated to other investment in their portfolio

  • Limitation on drawdowns


WHAT IS A SYSTEMATIC GLOBAL MACRO ABSOLUTE RETURN STRATEGY?

Systematic Global Macro Absolute Return Strategies seek to generate absolute return (positive returns) regardless of the economic environment and provide diversification to investors’ portfolios.

Let’s break down each component and why this strategy matters to RIAs.


Systematic: Systematic managers follow a quantitative approach to making investment decisions. This rules-based approach follows specific algorithms: trade entry, market selection, risk levels, and allocation percentages. It is a quantitative approach that utilizes mathematics and statistics in its portfolio creation extracting as much information from the past and applying that to capitalize on repeating patterns to generate returns.


Global: Global macro managers trade in multiple markets around the world, diversified by asset class and geography.


Macro: Macro managers trade every asset class, such as stock indexes, fixed income, currencies, and commodities. There are two schools of thought within Macro:

  • Discretionary: A subjective approach, often focused on the analysis of fundamental data, typically with concentrated bets.

  • Systematic: An objective, rules-based approach, often implemented through quantitative modeling of economic data, typically diversified across many positions.

Absolute Return: Absolute Return managers can generate returns regardless of the economic environment. Returns are not correlated to some of the largest investable asset classes such as public equity, fixed income, real estate and private equity.



WHAT ARE THE GOALS OF THIS STRATEGY?


Diversification: The prime objective of a multi-strategy program is to provide “true diversification” through our global approach across all major assets classes for investors who have portfolios allocated across equities, fixed income, real estate and even private equity.

Not Correlated: Ridgedale’s investment philosophy combines convergent and divergent strategies (as discussed in more detail below) to attain “true diversification.” Investors often compile a group of return streams/managers in their portfolios, believing that they are not correlated to one another as shown by past history.

But, when events disturb those correlations (the stock market crash in 1987, the Asian currency crisis and Russian debt default in 1997-1998, and the 2008 financial crisis for example), their portfolio will have very substantially large drawdowns as correlations of the portfolio components increases. We saw that in 2008 when fund-of hedge funds that were previously making 5-7% per year were down between 20-30% because the group of managers they put together all began to correlate, failing to provide the needed diversification.

The multi-strategy absolute return program aims to put together strategies and systematic programs that do not correlate with one another and make sure that the low correlation is maintained even in crisis events. This is accomplished by combining convergent strategies with divergent strategies.

  • Convergent strategies: Are based on the idea that markets are rational and value based, where assets may become mispriced, but will ultimately return to their intrinsic value. Convergent strategies look to profit on these mispriced markets by identifying undervalued or overvalued assets, aiming to profit from the price correction.

  • Divergent strategies: Capitalize on irrational behavior in markets, when fundamentals are seemingly discarded. Divergent strategies use past prices to predict future prices. They identify different trends and use trajectory models to provide a hedge to the convergent strategies. The top-level diversification between convergent and divergent strategies gives us the stability of performance and maintains a low average correlation of our models in a portfolio. Whether we are in a rational or irrational market environment, our goal is to provide persistent uncorrelated alpha.

As Harry Markowitz an American Economist and Nobel Prize winner in Economics stated, “A good portfolio is more than a long list of good stocks and bonds. It is a balanced whole, providing the investor with protections and opportunities with respect to a wide range of contingencies. Diversifying sufficiently among uncorrelated risks can reduce portfolio risk toward zero.”

We believe an allocation to actively managed Global Macro managers is a valuable element of a well-diversified portfolio. It is an all-weather strategy, even during the most difficult markets historically. Now is a critical time to consider Global Macro due to impending markets, strong performance, and portfolio allocation diversification.


WHAT ARE THE PROS AND CONS?


PROS OF A SYSTEMATIC GLOBAL MACRO ABSOLUTE RETURN STRATEGY


Positive stable performance that is uncorrelated to other investment in their portfolio.


Absolute return strategies offer two benefits: the diversification benefit and positive skewness (or good returns during crisis events).

Many investors do not have absolute return strategies in their portfolios and they have experienced significant market drawdowns in the past. Investors should not expect the same performance from equities that we have seen over the last 10+ years since the financial crisis. When investors consider the asset allocation (60% fixed income and 40% equity), they add fixed income to provide stability so that if equities drop, they will buy into a drawdown by allocating from the fixed income side to the equity side. If the equities bounce back, they will have a better return profile. This process is called rebalancing, which involves realigning the weightings of a portfolio. The rebalancing will be more beneficial when investors add absolute return strategies in their portfolio, because it is not subject to interest rate risks and allows investors to be more aggressive in their allocation.


Investors could allocate more to equities when they have the protection on the other side such that when equities decrease, they can reallocate from the absolute return strategy into the equity part of their portfolio.


Limitation on drawdowns: A drawdown refers to how much an investment or trading account is down from the peak, before it recovers back to the peak. Drawdowns present a significant risk to investors when considering the uptick in share price needed to overcome a drawdown.

For example, it may not seem like much if a stock loses 1%, as it only needs an increase of 1.01% to recover to its previous peak. However, a drawdown of 20% requires a 25% return to reach the old peak. A 50% drawdown, seen during the 2008 to 2009 Great Recession, requires a 100% increase to recover the former peak. Therefore, limiting drawdowns is important to investors.



CONS OF A SYSTEMATIC GLOBAL MACRO ABSOLUTE RETURN STRATEGY

Capacity constraints: Funds become too large so that their ability to diversify is constricted by liquidity in the markets they can trade. They are heavily focused on the financials and equity derivatives, and not as much in the less liquid macro markets.

Current investor sentiment: The past 10 years following the 2008 global financial crisis has caused some struggles for absolute return strategies, with artificially low volatility, inflated asset valuations, and almost no crisis events. This has led to a consistent climb to new highs in equity markets, with many in our space underperforming the major equity benchmarks, causing many investors to ask “why do I need your program in my portfolio when I’m making 20% in the stock market?” Investors do not appreciate the benefits of true diversification, but they will need it in their portfolios to avoid significant market drawdowns when systematic risks occur.


Market Volatility: One of the cons is that we do need some volatility in markets. Quantitative easing by global central banks (QE) has made performance more muted versus historical norms for the same strategy, although we still provided positive performance. Other funds have not. That last several years of QE is a unique period in time.


Special Thanks to Our Contributor

Ridgedale Advisors LP is an alternative asset management firm focused on systematic global macro absolute return and commodity specific strategies.


Phone: +1 (914) 740-8150

​www.ridgedaleadvisors.com


Peter Gorman

pgorman@ridgedaleadvisors.com


Paul Lucek

plucek@ridgedaleadvisors.com


Nick Katchadurian

nkatchadurian@ridgedaleadvisors.com

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