July post-mortem

July was really quite a fascinating month for a number of reasons. Aside from the obvious market-based factors (credit market implosion and concomitant risky-asset fallout), last month provided an interesting insight into different portfolio management techniques and highlighted the utility of a multivariate approach. After a number of months where beta was king, July demonstrated markedly different return profiles for static beta, active beta-plus, and alpha-generating strategies.

First, the bad news. After a promising start and generally solid performance throughout the month, July ended up as Macro Man's first losing month of the year, courtesy of the Tuesday's late-session swoon in the S&P 500. The return, -1.15%, dropped less than half of what Macro Man had made in each of the prior two months, and the blog portfolio still closed July up 7.5% on the year.
The primary culprit, unsurprisingly, was the equity beta portfolio, which shed 1.71% on the month. While the SPY position actually does represent a market-timing beta plus strategy, the threshold for exiting the position is so far away that it is tantamount to a passive equity long. And with the S&P 500 down 3.2% on the month, that spelled trouble for Macro Man and anyone else running beta-heavy strategies (more on that later.)

Much more satisfying was the performance of the FX carry beta plus portfolio, which notched a tiny gain despite catastrophic declines in most carry crosses in the latter portion of the month. While Macro Man took a costly round trip in FX carry early in July, his exodus from the basket a few days later proved fortuitous in the end. While a 0.07% monthly return on a carry strategy doesn't set the world on fire, it nevertheless beats the hell out the performance of a passive carry strategy, which dropped 0.87% on the month (see below.) Lopping off left-handed fat tails is one of the primary attractions of a "beta-plus", as opposed to pure beta, strategy.
All in, the beta strategies dropped 1.65% on the month- not great, but it could definitely have been worse. The alpha portfolio, meanwhile, made money in each of the three market segments (equity, fixed income, and FX) in which Macro Man had a position last month.
Macro Man was slightly unlucky insofar as his alpha portfolio index hedge (long the puts in a July 1520/1555 ESU7 risk reversal) expired more or less immediately before the stock market rolled over meaningfully. He dithered before purchasing more downside protection, allowing precious performance to slip away. The hedges that he did end up buying (DAX and FTSE puts) only made 0.12% for him in the last few days of the month.
Considerably more profitable, of course, was the short XHB position, which all in (cash short, long puts, long SPY hedge) made Macro Man around 0.96%. While he has subsequently closed the cash short, Macro Man can look back fondly on this trade as an obvious sectoral macro play that came good. The long equity portion of the Brazilian RV trade added 0.44%- a good return, albeit substantially less than the profitability at the stock market peak. All in, equity alpha bets added 0.21% to portfolio performance last month.
Macro Man notched a comparable return from fixed income bets. He essentially has a long inflation breakeven trade on, though with the nominal leg expressed in JGBs rather than Treasuries. This proved fortuitous, as the combined position more or less broke even during a month in which 10 year US breakevens declined five basis points. The SGD payer position, meanwhile, made 0.18%, which was the ultimate performance of the fixed income alpha portfolio during the month. If only Macro Man had gone short credit....
In currencies, Macro Man's only real bets were long volatility, albeit with modest short EUR/USD and USD/JPY betas. The short EUR/USD delta of his powerball portfolio more than offset the continued uptick in long-term volatility. However, the powerball loss was compensated by the vol and delta gains from the USD/JPY straddles. The overall return of 0.11% was modest but nevertheless positive, and took the all-told performance of the alpha portfolio to 0.50% for the month.

So there you have it. The buy-and-hold equity position took it on the chin, the active FX carry basket emerged unscathed from the yen-cross carnage, and the active alpha overlay generated modest positive returns across sectors. All-in, it's disappointing to lose money in any month, but the size of the losses, particularly in relation to prior gains, validates the underlying investment strategy of the blog portfolio.
And while hedge fund performance indices in many cases do not capture the best and brightest of the industry (who don't need to be included to sell their services), the recent fortunes of the HFR Macro hedge fund index (the white line in the chart below) does suggest that its constituents may need to adopt a more diversified investment strategy, lest their clients tire of paying two and twenty for what appears to be an underperforming equity beta strategy.

Focus today is on European central banks, as the BOE and ECB announce their rate decisions this afternoon. Neither is expected to move, but markets will parse the ECB press conference for signs of 'strong vigilance', which would foreshadow a rate hike next month.
Otherwise, it's as you were, with the SPX putting in a 'hammer' on the candlestick chart yesterday, which suggests to Macro Man that Wave B is here. That the mysterious late-session rally may have been caused by a miskeyed futures trade is neither here nor there; Macro Man now looks for the rally to extend over the next few days. Perhaps the Fed not throwing the market a dovish bone next Tuesday will be the catalyst for Wave C to commence. Hard hats on....
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August 3, 2007 at 2:29 AM ×


Excellent updates as always.


Way to go with that XHB cover! You couldn't have timed that better if you tried. I still think that XHB will head lower in the intermediate term, but that was a great cover.

On another note, doesn't it "seem" that the shorts are being set up for a squeezing in the builders, et al? Specifically, in only 30 minutes, the weak longs in BZH are entirely wiped out and replaced with strong hands with a basis well below the current prices. The following day the MSM reports a major fund with a large stake in BZH. Stock rallies, weak shorts are taken out. The only fly in the ointment with BZH specifically is that they have a lot (lot, lot, lot, lot, did I mention a lot?) of resistance overhead. Still, it will be worth watching in the coming days and weeks.

Don't you just love capitalism?

August 3, 2007 at 3:47 AM ×

HONG KONG: The first purchase by the Chinese government's new overseas investment fund, a $3 billion stake in the Blackstone Group, has backfired badly and produced an unusual public backlash within China.