Tuesday, January 31, 2023

Policy edge: how BlueBay’s macro product trades political ups and downs 

Russel Matthews

For Russel Matthews, lead portfolio manager for BlueBay Asset Management’s Global Sovereign Opportunities Fund, politics is primary.

“We have a strong belief there is a big inefficiency in the market in terms of the understanding of policy and politics and how that will develop through time.”

Matthews runs the macro strategy alongside BlueBay CIO Mark Dowding, who leads Mayfair’s best-networked hedge fund team in the halls of power in Westminster and beyond. They see their grasp of policy and politics as an edge.

“Identifying mispriced policies is a big focus for us,” says Matthews. “We spend a lot of time establishing relationships with the prime stakeholders in different policy-making environments: central bankers, politicians, civil servants, captains of industry.”

Policy edge

BlueBay’s instinct to cultivate relationships with policymakers on all sides came to wider attention in 2017 when managers met with John McDonnell, then-opposition finance minister in the UK, a firebrand socialist shunned by many in Mayfair and the City.

Matthews, Dowding and the team do their own proprietary research to “get under the skin of the macroeconomics” and focus on the usual indicators: growth, inflation, trade, current account deficits, fiscal numbers, debt sustainability.

But the policy edge is their differentiator. “We try to gain an understanding edge by understanding policies and their chances of success — and the impact on price action.”

The pair have always been aggressive macro risk-takers, but regard themselves as investors rather than short-term traders. “We look at markets from a structural medium-term perspective and focus on analysing and doing proprietary work for the case for investment in a particular story,” says Matthews.

The macro strategy, which currently runs about $500m in offshore and Ucits versions, deploys risk evenly across interest rate, sovereign credit and FX trades.

Simplicity, liquidity and transparency are watchwords when deploying trades, with a preference for benchmark instruments, government bond futures and interest rate swaps. “We have an aversion to financial engineering,” says Matthews.

Key 2022 themes

The approach has paid off this year, with gains across rates, sovereigns and FX putting the fund up 13.5% for the year to August, boosted by a 5% gain last month.

Two big macro calls drove the gains. “First, to be short US duration risk via the 10-year part of the curve and the Eurodollar money market instruments. That was based on our view that central banks were behind the curve on inflation and needed to catch up — as well as the underlying strength of US economy.

“Second, given our view on rates, we thought a stronger dollar was likely, we have been long the greenback all year, against the euro and a basket of EM currencies.”

The short duration thematic was a big driver of August performance. “In the summer we thought the market had got too pessimistic about the US economy, there was too much recession talk and focus on a hard landing/Fed pivot. We still thought they would need to deal with inflation and recession talk was secondary to this.”

Shorting UK gilts has also been a key trade this year. “The UK is in a vulnerable inflation position because of its energy structure, consumer-driven economy and big current account deficit. We expect this to continue —  in addition, the politics has been mediocre.

“All of the ills that face the global economy at the moment are more manifest in the UK, in terms of the potential for a severe stagflationary environment going forward. We are short the UK pound and bond market.”

A short in the German bund has also worked well. “The macro picture in the eurozone is extremely troubling because there is so much uncertainty with the Ukraine situation and Putin playing games with the energy supply. However, all the potential outcomes in Europe are inflationary. We see an increasingly hawkish direction of travel by the ECB. There is a lot of work to do in raising rates.

“We have also been short Italy and Spain in the European periphery. Given headwinds in terms of energy and inflation, the ongoing conflict in Ukraine and expected concerns over debt sustainability.”

Other idiosyncratic plays include a short in the Russian ruble in Q1 “because of a strong conviction that Putin was going to escalate and war was likely” and short lira in inflation-riven Turkey. “It is an unsustainable situation.”

Political focus

For Matthews, who grew up during the civil war in Zimbabwe, the importance of socioeconomics and geopolitics has never been in doubt.

It was underlined when he witnessed South Africa’s first free election in 1994 while studying for a degree in economics and journalism.

After starting his career as an investment writer, he got a break in 2000 when he was brought onto the fixed-income desk at Invesco by Dowding. They then moved to BlueBay in 2010 and launched the global macro fund at the end of 2015 after Neil Phillips and Jonathan Fayman had left to start their own firm, Glen Point.

Revenues earlier generated during the eurozone crisis for BlueBay’s other products showed the potential of the macro fund’s approach.

“We travelled a lot to Athens, Frankfurt, Brussels, Lisbon and other hubs,” says Matthews. “As a result we got ahead of the curve in terms of understanding how different countries would pull out of the nose-dive they had been in since 2009-10.

“In mid-2012, we flipped to a long position in Italy, Portugal and Slovenia. That was all down to our understanding of how the policy framework was going to change.”

Strategy outlook

The Global Sovereign Opportunities Fund is one of many macro funds to prosper during this year’s heightened volatility and inflation crisis. Macro funds made an average 9.3% in the first eight months, compared to average hedge fund’s 4% loss, according to HFR. 

“It is very satisfying to achieve that when long equity and fixed-income strategies are down double-digits. It shows the strategy can produce performance in any market environment.”

Conditions will remain volatile, says Matthews, who believes the economic crisis could be worse than 2008 and the Covid crisis. “There are no free lunches for policy makers — for the past 20 years, central banks and policy-makers have always been able to pull stimulus levers get us through crises.”

Further volatility and bigger political shifts should suit the strategy. “Macro and absolute return have had a bad rep in the last few years because a lot of risk-takers and a lot of strategies have been quite beta-oriented. What we proved this year is that we are agnostic on the market environment.”

The macro environment and the liquidity focus of the strategy means there is capacity for up to $4bn and investor discussions are encouraging, says Matthews. 

“All of our work has come to an apogee in this particular product,” he adds. “This is the best of BlueBay in terms of our capability in generating performance through investments in government bonds and FX.”