How Hedge Fund Manager Dan Loeb Thinks about macro and Express Their Bets
Hedge fund activist investor Dan Loeb makes a large amount of bets based on macro. His view is worth sharing here as he has built great track record. His Offshore Fund gained 17.5% a year since inception in 1996. During the same period S&P500 gained only 6%.
This is what he wrote in the latest shareholder letter regarding to macro:
Generally, we think about macro and express our bets in three ways.
First, since 2009, we have maintained a basket of "tail" trades, usually amounting to about 50‐100 basis points of protection. We try to cushion the portfolio against various tail event risks including a war in the Middle East, EU sovereign defaults, contagion from Eastern Europe peripheral countries' stress, Japanese fiscal weakness, the sustainability of China's pace of growth, pressure on the Fed's control over rates and its balance sheet, and a global growth slowdown. We structure these trades in a variety of ways including via commodities, currencies, rates, swaps, puts and calls. This "tail risk" portfolio has remained fairly steady in overall size since its inception, and we expect it to remain roughly in this range indefinitely. The key is that these positions should provide some insurance when and if we most need it, with limited costs in the (hoped for) event that the worst never materializes.
Second, we will occasionally find it more effective to hedge out a specific stock sector or geographic bet in our portfolio using a macro type of trade. As an example, last year, our bottom‐up equity book was bullish on Chinese growth through multiple single name stocks listed on Western exchanges whose profit drivers were exposed to the Chinese consumer. To hedge against this long positioning, we might have put on a basket of single name Chinese equity shorts. We hedged instead by making a bet that Australian interest rates would come down if Chinese growth declined and initiated a position focused on the long end of the Aussie rates curve, which was then reflecting the consensus belief that rates would continue to rise. Since Australian growth is driven primarily by natural resources and thus commodity prices, each of which is heavily dependent on the country's exports to Chinese buyers, if China wobbles, Australia totters too. This macro insight allowed us to effectively and relatively inexpensively hedge out some of our long equity book's downside exposure to weakening Chinese growth.
Finally, we will sometimes make outright macro investments that appeal to us using the same framework we apply to equity or credit positions. During the Third Quarter of 2011, we recognized that copper had materially outperformed other base metals in the deteriorating global economic environment. We initiated an options trade to take advantage of falling copper prices and capitalize on relatively low implied volatility priced into the options. Expressing our view via an options trade allowed for defined, inexpensive risk and greater upside than shorting the metal itself. This investment allowed us to press our view that liquidity was tightening in China due to a curtailing of grey market and off balance sheet lending and was a profitable way of capitalizing on our insight on the short side. Below, we discuss a current trade in Portuguese sovereign bonds that fits the classic Third Point "forced selling" parameters that are reliably profitable, in this case applied to sovereign rather than corporate bonds.