Brent's run ain't spent say experts as macro enjoys a barrel of laughs
Oil drove the global macro markets in May, cementing futures-based strategies' non-correlation to traditional asset classes
David Murrin, chief investment officer at Surrey-based directional global macro fund managers Emergent Asset Management, says, as of 5 May, that in the emerging markets world, the emerging markets bond index (EMBI) has peaked after nine years of a "massive rally".
So much for the good news - the bad, at least for those who cannot run a short book, is that it leaves the market in for a "significant bear market" in EMBI product.
"This price decline should also be accompanied by a widening of spread. We started the trade this year by being short in Brazil and Turkey and then diversified into other emerging market bonds," Murrin says.
Once the general asset-wide decline in price has gained momentum, Emergent would expect to see country-specific problems become the focus in the near term, according to Murrin.
"We have been bearish on fixed income since February this year and we view current (4 May) levels as being at an inflection point, with either breaks lower or corrections to higher prices representing levels to sell fixed income again," he says.
Emergent runs three global macro portfolios - the Cosmopolitan Fund in developed markets, the Diversified Fund in emerging markets and the Global Fund.
Murrin adds, on equities, that Emergent believes the liquidity rally from capital injections by the US Federal Reserve and other central banks is over and that current moves represent the "whole correction to the bear market from 2000-2003 - the risk now is that another bear follows."
Emergent has been bearish on emerging market equities during the recent decline, but Murrin says in the longer term, he expects Eastern economies - China, Taiwan and other regional players - to become relatively stronger as the West loses its historic economic dominance.
"Our long-term roadmap for the decade is on target and suggests the rally of 2003 was a correction in a long-term bear market. The past few months extended the rally further than we expected, though the Dow Jones Industrial Index spent February largely below the critical 10700 level. The quarter-one 2004 sell-off seen in most Western equity markets represented the first stage of a topping process, which now seems well underway." Emergent expected to see this move accelerate during May.
"As was the case during the 2003 March equity low, the SOX Index led the reversal and, once again, seems to be leading the change in direction. We expect to see a significant decline during the second and third quarters of 2004," Murrin says.
Perhaps the main large play Emergent is making is on oil, where the risk of terrorist attacks on installations combined with under-supply and excess demand from the East could see the barrel price head toward the $50-$60 mark. "It has spent far too much time in the $30-$40 range," Murrin says, "but they're not finding new oil and there is a peak in production we are at now."
On 5 May, Murrin noted oil seemed "one of the major ingredients of the May trading cake and, with the current trading patterns, we expect to see a very powerful rally that will take oil to the $60 level in the next three months."
Commentators have been taken aback as the dated Brent hit $39.19 as at 14 May, with the first month NYMEX future $37.90.
In the managed futures, macro and CTA region, says Laurent Favre, head of tactical asset allocation at UBS Wealth Management, exposures to those strategies in funds of funds should be increased as extreme risk is taken into account and becomes more likely.
As the conditional value at risk (CvaR) runs from 85% to 99%, and extreme risk increases, Favre says, the proportion of CTA needed in a fund of hedge portfolio rises from less than 10% up to more than 20%. (See accompanying chart, left).
The amount required using modified VaR (MvaR) also rises, using Edhec index data from January 1997 to February 2004 (that is, through the crises of 1998) from less than 5% up to 18%, he adds.
"If you do not care about extreme risk, by all means have distressed securities, but if you care about extreme risk, and think that the bad lessons of history may repeat themselves, then you need to have managed futures/CTAs," Favre says.
The global macro strategy, according to analysis of Edhec indices, has shown annual volatility of 6.57%, and a skewness of 0.9.
The macro strategy has shown a maximum drawdown of 5.4% over the period and nine months underwater, far less than the 30 months for equity long/short and 28 for emerging markets.
key points
key points
Oil continued to be the main commodity driving some macro managers as prices breach $40.
Experts predicted a 33% rise from these levels to tip $60 per barrel in the future.
Managed futures and CTA should increase as a proportion of fund of hedge fund holdings if investors believe extreme risk will recur.
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