The global-macro strategy is the method of investment that buys or sells all kinds of financial instruments according to macroeconomic affairs. The strategies used by hedge funds are known for profiting without depending on the trends of the markets, hedging various risks. In this article, we review how to hedge risks with the global-macro strategies, introducing examples from the current markets.
In Europe, there are some worries about the low inflation, and therefore the European Central Bank (ECB) decided to ease their monetary policies. In this kind of situation, one of the effective strategies is to buy real estate stocks. We formulate this as follows:
- Low inflation -> Monetary easing -> Property prices rise
However, there are some unconsidered risks in this investment. For instance, if the euro falls much faster than the easing affects the property prices, the import prices could go up and increase the inflation. This could be an incentive for the ECB to stop easing.
- Low inflation -> Monetary easing -> Weak currency -> High import prices -> Monetary tightening -> Property prices fall
Here, we observe the low inflation affects both rising and falling of the property prices. In order to hedge the risks of the currency weakened, we can either short sell the currency or buy exporters.
- Low inflation -> Monetary easing -> Weak currency ->Exporters benefit
And the risks of the currency weakened to the property prices are now hedged. This is the basics of the global-macro risk hedging, but isn’t the end of the story.
After longing the property companies and shorting the euro, the investor finds their portfolio hugely relying on the easy monetary policies. It should be okay in the early stage of the bubble, but as the market booms, the huge exposure to the monetary easing becomes a risk. Although It’s one way to reduce the position, another way, in this case, is to buy insurers.
In the current situation of the European economy, the monetary tightening should occur when the economy recovers and the inflation rate starts to hike, and generally speaking, the insurers would benefit from the rate rise, reducing the risks in the portfolio. They would also benefit when the demand recovers, and so this could be good investment in the situation.
- Economy recovers -> Inflation rate rises -> Monetary tightening -> Interest rates rise -> Insurer benefit
Like this, we sometimes invest in different themes, such as monetary easing and tightening. In the global-macro strategy, all the positions try to kill the risks of each other, ideally achieving 20-30% per year without huge volatility. The most important thing here is that each position stands alone as good investment, constituting the entire portfolio well-hedged. A position just made for hedging could just create an unnecessary loss. It’s the technique of the hedge fund manager to achieve both macroscopic and microscopic ideals.