The (declining) benefits of macro hedge funds

Many hedge funds sell their approach as good diversification to traditional stock/bond portfolios. But if you look at the diversification benefits of hedge funds, you will find that the majority of hedge fund strategies come up wanting. In practice, they tend to have rather high correlation with stock markets. One hedge fund style that is truly uncorrelated is global macro together with its close cousin managed futures. I like global macro hedge funds, but then again, I would say that since I am a macro junkie. So, let’s take a fresh look at the evidence, or lack thereof, for their diversification benefits.

In theory, the big advantage of global macro and managed future funds is that they can go anywhere where there is an opportunity. They can go long equities one day and short bonds the next. That should give them an edge particularly in bear markets. But when markets do not trend in either direction or trends change too fast, global macro funds will struggle.

In theory then, these ‘go anywhere’-funds should have very low correlation with stocks markets. And according to a new study by Rodney Sullivan and Matthew Wey that looked at returns from 1994 to the end of 2022 this promise is kept. The correlation between the S&P 500 and global macro and managed future funds is very low. And it is much lower than the correlation between the S&P 500 and long-short equity hedge funds, the most popular strategy in the hedge fund universe.

Diversification benefits of hedge funds

Source: Sullivan and Wey (2024). Note: GM = Global Macro, MF = Managed Futures, LSE = Long-Short Equity.

Indeed, looking at the performance of portfolios with and without these hedge funds one can clearly show that including global macro and/or managed futures hedge funds improves the stability of a traditional stock/bond portfolio. This is driven not only by the low correlation of macro hedge funds with stocks and bonds, but with their tendency to show high returns in equity bear markets. This has recently been confirmed once again when in the bear market of 2022 macro hedge funds performed strongly, supplying an effective diversification benefit.

But unfortunately, there is bad news as well. Hedge funds have struggled with declining returns over the past two decades and that is also true for global macro and managed future funds. The chart below shows that the raw alpha vs. the stock market of global macro and managed futures funds has more than halved in the last 15 years compared to the years 1994 to 2008. But at least there is still some alpha left, which is not something that can be said of long-short equity funds.

The alpha of hedge funds is declining

Source: Sullivan and Wey (2024). Note: GM = Global Macro, MF = Managed Futures, LSE = Long-Short Equity.

Yet, this alpha shown above for global macro and managed futures may itself be a mirage. It is measured as outperformance of these hedge funds adjusted for their market beta vs. the S&P 500. But these funds aren’t invested just in equities but can go anywhere. So, to be honest, one needs to adjust their performance for a whole range of systematic risk factors in stocks, bonds, and other markets. And if one does that, one gets the alpha shown in dotted lines below.

True alpha for global macro and managed futures funds

Source: Sullivan and Wey (2024). Note: GM = Global Macro, MF = Managed Futures.

Looks like managed futures don’t really create any alpha at all while the true alpha of global macro funds is about half the alpha shown in the second chart above.

Which brings me to my conclusion. If you want to invest in hedge funds, global macro hedge funds are still a good diversifier and a worthwhile addition to a traditional stock/bond portfolio. But don’t expect any miracles from them. Their returns tend to be low, and their true alpha is about 1% per year. Not a lot, but not nothing either.