The Trouble with Macro

Markets around the world start the week bracing for trouble as Greece spirals further into crisis. Can the country avoid a full-blown default? Will there be a Grexit? Will it stay in the euro zone and keep the single currency? It all looks like an unknowable gamble.

Which leads us to this question: How big a challenge is it to make big bets about big macro questions at big hedge funds?

Based on what we have seen so far, the short answer is: It is extremely challenging. Indeed, macro funds have been doing poorly throughout this recovery cycle, despite big events and broad trends. You might think this environment would be ideal for the sort of traders who make large bets on big macro events, but recent performance data suggests otherwise.

It is especially fascinating when you consider that the Greek financial drama began unfolding in December 2009, when credit ratings agencies first downgraded the country’s debt. Then, in May 2010, there was a $146 billion rescue package, including a self-destructive austerity requirement that doomed the process to failure.

And fail it did. Less than two years later, in October 2011, Greek debt was restructured, with a 50 percent haircut. Depending on your point of view, that restructuring was either a great opportunity to pick up distressed assets on the cheap, or an early warning of more pain to come.

About 30 billion euros of Greek government debt securities emerged from a 2012 restructuring of private sector bonds. This was the catnip that enticed some of the larger trades by big smart hedge funds.

The New York Times reported that the “largest investors include Japonica Partners in Rhode Island, the French investment funds H20 and Carmignac, and an assortment of other hedge funds like Farallon, Fortress, York Capital, Baupost, Knighthead and Greylock Capital.”

Other specific trades include Greenlight Capital and Paulson & Co., “both of whom have invested and lost considerable sums in Piraeus Bank. Fairfax Financial Holdings and the distressed investor Wilbur Ross own a large stake in Eurobank, one Greece’s four main banks.”

The Times also noted large speculative investments by Fortress Capital in discounted debt belonging to Attica Holdings ($100 million) and York Capital in GEK Terna (10 percent stake).

These large bets by established funds with excellent track records suggest some very deep research into the creditworthiness of the players involved and the probable outcome.

This is no small irony, given the history of Greece. As my colleagueJosh Brown noted, “no countries in the modern world that have defaulted on their loans more often than Greece, save for Honduras and Ecuador.” He added, “The government of modern Greece has defaulted five times in 1826, 1843, 1860, 1894 and 1932.”

Perhaps the biggest issue for macro funds seems to be an overreliance on narrative. The underlying investment thesis is a story. To work, it must follow a series of twists and turns that unfold in a very specific way, on a very specific timeline. Compare that with value investing, which is much more math-driven because it relies on mean reversion. A reliance on mathematics is also true for quant funds.

And that’s the trouble with macro. Large, potentially destabilizing events are unpredictable. Reactions to subsequent chains of unanticipated of reactions and counter-reactions are also inherently unknowable. No wonder macro funds have been struggling, despite the series of huge macro events that have unfolded over the past decade.

The outcomes to these speculations are binary. Some funds will win big as others lose. Events over the next week may very well determine who is who in the Greek drama.

Originally published as: The Macro Funds’ Big Greek Gamble