Quant Macro Investing

Risk Taking Disciplined

Macro Investing

Does macro investing work?  You probably get the answer “sometimes”.  However, it is definitely gaining respect after the recent financial crisis (actually, I would say we are still in the crisis?).

Below is from well known hedge fund manager David Einhorn of Greenlight Capital.  While seeing himself as a “bottom up” value investor, David is recognizing the importance of getting “insurance” based on macro view.

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(David Einhorn, full 10-page article here) … At the May 2005 Ira Sohn Investment Research Conference in New York, I recommended MDC Holdings, a homebuilder, at $67 per share. Two months later MDC reached $89 a share, a nice quick return if you timed your sale perfectly. Then the stock collapsed with the rest of the sector. Some of my MDC analysis was correct: it was less risky than its peers and would hold-up better in a down cycle because it had less leverage and held less land. But this just meant that almost half a decade later, anyone who listened to me would have lost about forty percent of his investment, instead of the seventy percent that the homebuilding sector lost.

I want to revisit this because the loss was not bad luck; it was bad analysis. I down

played the importance of what was then an ongoing housing bubble. On the very same day, at

the very same conference, a more experienced and wiser investor, Stanley Druckenmiller,

explained in gory detail the big picture problem the country faced from a growing housing

bubble fueled by a growing debt bubble.

At the time, I wondered whether even if he were correct, would it be possible to convert such big picture macro-thinking into successful portfolio management? I thought this was particularly tricky since getting both the timing of big macro changes as well as the market’s recognition of them correct has proven at best a difficult proposition. Smart investors had been complaining about the housing bubble since at least 2001. I ignored Stan, rationalizing that even if he were right, there was no way to know when he would be right. This was an expensive error.

The lesson that I have learned is that it isn’t reasonable to be agnostic about the big

picture. For years I had believed that I didn’t need to take a view on the market or the

economy because I considered myself to be a “bottom up” investor. Having my eyes open to

the big picture doesn’t mean abandoning stock picking, but it does mean managing the longshort

exposure ratio more actively, worrying about what may be brewing in certain industries,

and when appropriate, buying some just-in-case insurance for foreseeable macro risks even if

they are hard to time. …

At the May 2005 Ira Sohn Investment Research Conference in New York, I
recommended MDC Holdings, a homebuilder, at $67 per share. Two months later MDC
reached $89 a share, a nice quick return if you timed your sale perfectly. Then the stock
collapsed with the rest of the sector. Some of my MDC analysis was correct: it was less risky
than its peers and would hold-up better in a down cycle because it had less leverage and held
less land. But this just meant that almost half a decade later, anyone who listened to me
would have lost about forty percent of his investment, instead of the seventy percent that the
homebuilding sector lost.
I want to revisit this because the loss was not bad luck; it was bad analysis. I down
played the importance of what was then an ongoing housing bubble. On the very same day, at
the very same conference, a more experienced and wiser investor, Stanley Druckenmiller,
explained in gory detail the big picture problem the country faced from a growing housing
bubble fueled by a growing debt bubble. At the time, I wondered whether even if he were
correct, would it be possible to convert such big picture macro-thinking into successful
portfolio management? I thought this was particularly tricky since getting both the timing of
big macro changes as well as the market’s recognition of them correct has proven at best a
difficult proposition. Smart investors had been complaining about the housing bubble since at
least 2001. I ignored Stan, rationalizing that even if he were right, there was no way to know
when he would be right. This was an expensive error.
The lesson that I have learned is that it isn’t reasonable to be agnostic about the big
picture. For years I had believed that I didn’t need to take a view on the market or the
economy because I considered myself to be a “bottom up” investor. Having my eyes open to
the big picture doesn’t mean abandoning stock picking, but it does mean managing the longshort
exposure ratio more actively, worrying about what may be brewing in certain industries,
and when appropriate, buying some just-in-case insurance for foreseeable macro risks even if
they are hard to time. In a few minutes, I will tell you what Greenlight has done along these
lines.

October 21, 2009 - Posted by | ABCs for Investing

2 Comments »

  1. […] think we can add value here, as we are with a hedge fund that invests based on macro understanding (here more for macro […]

    Pingback by Simple Quant Investing « Quant Investing | October 21, 2009 | Reply

  2. I think macro-investing is good and I will explain what I thought in the followings.
    Macro-investing is based on the predictions of the trend of economy, for example, if you predict there will be inflation and increasing growth of the global economy, and therefore you expect that oil price will increase in the long term, you would include some integrated energy companies in the portfolio.
    In my opinion, the main point is that you change the portfolio composition continuously as time goes by, so that you will not miss all the short term investment opportunities. Putting this into the writer’s case, he can still pick his favorite stock in the short term, and while time passes and the housing bubble becomes larger and larger, the writer should buy some insurance or decrease the proportion of MDC Holdings continuously, like from 10% to 5% or even lower when time passes.
    However, it is sometimes difficult to predict the size of the macro economy and its arrival time and therefore, involving macro-investing strategy may sometimes miss the profitable investment opportunities. I think the question is how to balance macro-investing and other strategies.

    (It is my first time to write here, please state out any mistakes I made)

    Comment by HK warwicker | October 21, 2009 | Reply


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