“If you ever pick up an FT or listen to a Bloomberg TV, they’ll often say the S&P fell 3.5% this afternoon and they’ll give you a reason,” said Dave Fishwick, head of macro investing at M&G Investments and manager of the M&G Episode Macro strategy.
“Very seldom do you listen to Bloomberg and they would say the S&P fell 3.5% this afternoon for no apparent reason. The point is that there are behavioural, emotional responses to markets that are difficult to account for and we also happen to think that they are the most fertile and exploitable inefficiencies you can see.”
Fishwick’s comments came during a recent roundtable discussion with several senior fund selectors in Singapore hosted by FSA and encapsulate neatly what has underpinned the strategy.
Although most macro funds did well last year on the back of trends like the strengthening US dollar and rising interest rates, the reasons for Episode Macro’s performance were different.
Episode Macro eschews the forecast-based approach that underpins most other macro strategies and instead is firmly rooted in behavioural psychology, seeking to exploit movements in prices that are potentially behaviourally or emotionally driven.
This has meant that the strategy has been able to deliver fairly consistently high single digit returns since the global financial crisis while maintaining a Sharpe ratio of near one, whereas most other macro funds struggled before last year due to the absence of volatility.
“Systematically out-forecasting the world on economics is a tough ask and the genesis of the strategy came from my previous experience as an economist. When we would get forecasts more correct than the consensus, often markets didn’t do what you would expect them to do.”
“Behavioural finance was emerging as a major stream of thinking at the time that we launched the strategy and it seemed to me this was a much more plausible assessment of what was happening to asset prices in the real world than any forecast.”
Plan from the Pru
Episode Macro began in 1999 when Fishwick was tasked with managing capital for an internal life fund for M&G’s parent company, Prudential. To this day, the bulk of the strategy’s assets are managed for Prudential even as total assets under management have swelled to around $4.5bn.
Fishwick started managing external capital in 2003 and then launched a Cayman Islands fund in 2005 followed by a UCITS version in 2010.
The scope of the strategy is primarily at the macro level including equity indices, government debt and foreign exchange, albeit the strategy does not invest in commodities directly.
The strategy has an absolute return focus so its neutral position is cash, albeit it has only spent about four and a half months without any positions on. The first three and a half of those were in 2002 at the end of the TMT bubble, while it also spent about three and a half weeks in October last year with no positions on as the portfolio transitioned from being short the rates cycle to actually being long bonds and Asian equities.
The strategy involves a lot of scaling, meaning that when positions work for them, Fishwick and his team reduce the size of those positions, while at the same time, they often increase their positions on setbacks. As a result, stop losses do not feature in the strategy and the strategy is willing to tolerate temporary setbacks.
At its heart, the strategy is price contrarian with a focus on reacting to how others invest rather than seeking to obtain an informational edge, albeit the starting point for the strategy is valuation.
“The last 15 years have been much more about episodes but even when we do episodic investing, we won’t do it with the wrong value signs by which I mean if I thought the S&P was episodically cheap but not value cheap I wouldn’t go long of it. You have got to have the signals working in the same direction,” said Fishwick.
Patient Opportunism
Hedge funds proved popular among asset allocators last year as they sought refuge from some of the volatility in public markets even though data from Preqin show that the industry’s returns were -6.5% last year, the worst year since the global financial crisis.
Macro funds were especially popular among fund selectors though and the reasons were even more justified. Well-known macro firms such as Bridgewater Associates and Brevan Howard Asset Management posted double-digit profit growth, largely on the back of directional rates trades.
Episode Macro may differ from most other macro funds in its philosophy but the argument for its inclusion within a portfolio is at least equally compelling, particularly as its ability to short assets has proven powerful after a tumultuous year.
“The key point that I’d emphasise is that for a very long period of time, multi-asset strategies have taken care of themselves. Our view is that 2022 was a wake-up call in terms of the ability to play assets from the short side. To have an absolute return mindset, you need to have the ability to play assets from the short side,” said Gautam Samarth, deputy fund manager for Episode Macro, at the FSA roundtable event.
After a challenging 2021, the strategy navigated last year’s travails with aplomb as they took advantage of the rise in cash rates largely through shorting Treasuries as well as European bonds before switching their stance to long bonds after the rally in September.
The portfolio currently comprises a collection of equities, primarily value and Asia-focused, as well as US Treasuries and emerging market FX. The book is much smaller than it was at the start of the year though and given last year’s performance, this naturally begs the question how Episode Macro can repeat this. Fishwick stresses patient opportunism.
“People ask us where are you going to try to repeat last year’s performance from? I would stress very strongly one of the things we learned is don’t try to force this. Markets are normally on some new journey to a bubble or a fad or an excited phase or a pessimistic phase and part of the skill here is being willing to wait for those things to develop or emerge,” he said.
Important Information
The value of the strategy’s assets will go down as well as up. This will cause the value of your investment to fall as well as rise and you may get back less than you originally invested. Past performance is not a guide to future performance The views expressed in this document should not be taken as a recommendation, advice or forecast. In Singapore, this material is issued by M&G Investments (Singapore) Pte. Ltd. (company registration number: 201131425R), regulated by the Monetary Authority of Singapore. In Hong Kong, this material is issued for Professional Investors only by M&G Investments (Hong Kong) Limited, located at Unit 1002, LHT Tower, 31 Queen’s Road Central, Hong Kong. If you have any questions about this material please contact M&G Investments (Hong Kong) Limited. Not for onward distribution. No other persons should rely on any information contained within. All forms of investments carry risks. Such investments may not be suitable for everyone. The information contained herein is provided for information purposes only and does not constitute an offer of, or solicitation for, a purchase or sale of any investment product or class of investment products, and should not be relied upon as financial advice.
