Understanding the drivers of Macro-Hedging strategies
One of distinguishing factors of the Multi-Asset team’s process is its multi-scenario approach. Using a top down approach, we build a central investment scenario, meaning the most likely scenario over the next 6 to 12 months period, and a set of alternative scenarios. These alternative scenarios are short to medium scenarios, which the team believes would be the most detrimental to the absolute or relative performance of our portfolios.
We assign to each scenario a probability of occurrence and assess their potential market impact. The team has developed a systematic process of analysing the “what could go wrong? When? And why?” (catalysts) from a macro view (top down) and per asset class (digging into market pricing is very important).
While we invest for the central scenario, we aim to increase its convexity by seeking assets that would benefit in the alternative scenarios while not being too expensive to carry in the central one. These “macro-hedges” allow us to search resiliency in our portfolio construction.
1. Macro hedging risk budgeting
The sizing of the hedges results from a judgmental and an analytical approach.
Using as a gauge our confidence in macro environments and valuations, the team assesses an overall risk appetite that ranges between 1 and 10 and sits today at 6. This helps portfolio managers decide on their use of absolute risk budget for absolute return strategies and on their use of tracking error budget for benchmark relative strategies.
Within that risk budget, portfolio managers will use macro-hedging strategies to adjust the level of risk taking in the portfolio. A highly effective macro-hedge will allow the PM to take more risk for a given risk budget. So as to assess the effectiveness of a hedge, the portfolio manager will leverage models developed by the team that assess fair values in central and alternative scenarios, using different sets of macro assumptions for each scenario. This will give them a sense of performance impact on the portfolio.
2. Macro hedging examples
Over the last 12 months, we have considered 2 major alternative scenarios. The details have changed over the year (for example the level of GDP growth or oil price) but their main characteristics have remained broadly the same:
It is for these scenarios that we considered various macro-hedging strategies. Each ought to have an asymmetric payoff (i.e. not too expensive in the central scenario but providing returns in the alternative scenarios), relative cheapness, and high liquidity. We always use a number of them to diversify our exposure. Strategies considered include for example US Treasury bonds, volatility (option strategies), USD, JPY and gold.
Gold miners in December 2016 exhibited for example the 3 qualities required for a good macro hedge:
- A close to 0 correlation with U.S. equity markets over the last 2 years;
That being said, by March, Gold miners equity had appreciated significantly and we considered that their return profile was no longer asymmetric, therefore offering reduced opportunity for hedges.
Specific risk hedge : political risk. Recent referendums or elections have been especially challenging to maneuver this year. We have used a similar approach, investing for the mainstream scenario but having positions that can offer good protection in case we are wrong. For example, at the time of the BREXIT referendum, we decided to favor CHF exposure as it would offer a reasonable cost of carry while providing good protection in case the Euro zone was under pressure. A GBP or a EUR exposure would have proven too symmetric, with a very positive gain in case of a favorable outcome but also a very large pain if the vote went the other way.
We believe our multi-scenario approach to be a key strength of our investment process: having the central scenario right is crucial, but limiting the drawdown in adverse circumstances will generally make the difference.
Karin Franceries, CFA
Senior Investment Manager, Multi-Asset Solutions
Gross performances of our strategies (March 31, 2017)
Amundi, data as at end of March 2017. Gross performance of “Balanced Institutional Absolute Return Low volatility “, Multimanager Multi-Asset Fund of Funds (Bonds)“ GIPS composites in euro. Their respective benchmarks are: Eonia capitalized and a composite benchmark: 50% JPM EMU Government Bond Index, 30% JPM Government Bond, 20% Exane ECI – Europe Convertible. Past performance is not a reliable indicator of future results or a guarantee of future returns.