Alpha Measurement in Macro

I've been a bit curious about how alpha is measured and preserved in the macro space. From my understanding in equity funds, once you compute how much of your return is attributable to the market risk premium using CAPM, the spread between your portfolio return and that is alpha. And then after that, you calculate your idio risk by understanding your factor exposures to get 'pure' alpha.

In macro though, how are the risk premia assessed? My guess is in macro because of the higher comparative variance in types of trades, horizons, and processes, idio risk can be easier to define by analyzing how much of your book is tilted to commodities, rates, geography, etc. How do PMs then assess their systematic risk exposures? Are they benchmarked against a macro index and then from there are returns attributed to said index of choice?

 

In the macro investing space, measuring alpha involves a nuanced approach due to the diverse nature of assets and strategies employed. Unlike equity funds where CAPM and specific market indices can serve as benchmarks for calculating alpha, macro funds engage in a broader spectrum of investments including commodities, currencies, interest rates, and geopolitical events, making the assessment of alpha more complex.

  1. Risk Premia Assessment: In macro funds, risk premia are assessed by identifying the underlying risk factors that drive returns across different asset classes. This involves a deep analysis of global economic trends, monetary policies, and geopolitical risks. The identification of these risk premia is crucial as it helps in understanding the sources of returns beyond what could be expected from a traditional equity or bond market exposure.

  2. Idiosyncratic Risk: For macro funds, idiosyncratic risk or 'idio risk' is often defined by the fund's specific exposures to various asset classes, regions, or economic indicators. This is where the fund's strategy and the portfolio manager's (PM's) expertise play a critical role. By analyzing the portfolio's tilt towards certain commodities, interest rates, currencies, or geographies, PMs can better understand the unique risks their portfolio is exposed to. This analysis helps in isolating the 'pure' alpha generated by the fund, distinct from the broader market movements.

  3. Systematic Risk Exposures: Assessing systematic risk in the macro space can be challenging due to the lack of a single, universally accepted benchmark. However, PMs often benchmark their performance against a macro index or a combination of indices that closely align with their fund's strategy and asset allocation. These benchmarks could include broad market indices, commodity indices, or even custom-made indices that reflect the specific risk factors the fund is exposed to. By comparing their returns to these benchmarks, PMs can attribute part of their returns to the systematic risk captured by the index, with the residual being attributed to alpha.

  4. Return Attribution: After establishing the benchmarks, return attribution in macro funds involves dissecting the portfolio's performance to understand how much of the return is due to market movements (captured by the benchmark) and how much is due to the PM's decisions and strategy (alpha). This process is crucial for evaluating the PM's skill in navigating the complex macro landscape and generating returns that exceed the systematic risk exposure.

In summary, measuring alpha in macro funds requires a comprehensive approach that accounts for the diverse and global nature of their investments. By carefully assessing risk premia, understanding idiosyncratic risks, and benchmarking against relevant macro indices, PMs can effectively evaluate their systematic risk exposures and isolate the 'pure' alpha generated by their strategies.

Sources: Is the common view of financial risk completely wrong?, Reflections from year 4 as an equity analyst, On the Job With Simple As… My Research Process, January 2016 Data Update 1: The US Equity Markets, Q&A: First year macro hedge fund analyst

I'm an AI bot trained on the most helpful WSO content across 17+ years.
 
Most Helpful

The only people at a HF who do this are middle office/risk players. This type of breakdown is done often at asset managers for sales purposes where they try for example to attribute how their small cap fund beat the R2k benchmark. Macro HFs don’t need to be invested at all times, and a good sign is knowing when to be risk on versus risk off, or knowing which factors to concentrate in. Academics will love to attribute a hedge funds performance to overly investing in tech or growth or some other factor/attribute, but it takes a lot of skill to know which factor/attribute/sector to be overweight/underweight.

 
Damian-Lewis

The only people at a HF who do this are middle office/risk players. This type of breakdown is done often at asset managers for sales purposes where they try for example to attribute how their small cap fund beat the R2k benchmark. Macro HFs don’t need to be invested at all times, and a good sign is knowing when to be risk on versus risk off, or knowing which factors to concentrate in. Academics will love to attribute a hedge funds performance to overly investing in tech or growth or some other factor/attribute, but it takes a lot of skill to know which factor/attribute/sector to be overweight/underweight.

this still sounds like factor trading still. I always thought traders have some intutively sense of the future factor risk & return in the future, how the factors are correlated, adjust portfolio accordingly. It not may all be optimized but there is a gut feeling of these relationships and breakdown of return and risk. Or if traders will trade RV, they will hedge out the factor part and try to trade the specified piece, which would hopefully be positive

 

Not too knowledgeable about relval but with those trades aren't you inherently flat on your exposure to a factor - like if you're doing a curve trade then directionally speaking you're exposed to interest rate risk but when you combine those two different views of the curve, e.g. you net out your directional exposure.

 
portfolio_manajer

Not too knowledgeable about relval but with those trades aren't you inherently flat on your exposure to a factor - like if you're doing a curve trade then directionally speaking you're exposed to interest rate risk but when you combine those two different views of the curve, e.g. you net out your directional exposure.

You’re exposed to curvature or convexity risk which u can consider a factor

 

Tempore consequuntur voluptatem numquam maxime non eius voluptate aut. Sed non illum consequatur eos velit. Molestias quaerat a quos ad. Beatae ipsum officiis commodi eligendi vel velit quia. Voluptatibus molestiae maiores voluptatem sunt illo aut.

Odio illum recusandae corrupti esse sit similique. Fuga cum magni doloribus quas. Delectus quas autem similique modi et et.

Ea earum sunt sint commodi non culpa beatae. Reprehenderit repellat qui hic non.

Occaecati tempora alias sunt in culpa est consectetur aperiam. Nihil quia aut libero nam aspernatur magni. Culpa unde velit inventore minus natus ab ut dolore.

Career Advancement Opportunities

May 2024 Hedge Fund

  • Point72 98.9%
  • D.E. Shaw 97.9%
  • Citadel Investment Group 96.8%
  • Magnetar Capital 95.8%
  • AQR Capital Management 94.7%

Overall Employee Satisfaction

May 2024 Hedge Fund

  • Magnetar Capital 98.9%
  • D.E. Shaw 97.8%
  • Blackstone Group 96.8%
  • Two Sigma Investments 95.7%
  • Citadel Investment Group 94.6%

Professional Growth Opportunities

May 2024 Hedge Fund

  • AQR Capital Management 99.0%
  • Point72 97.9%
  • D.E. Shaw 96.9%
  • Magnetar Capital 95.8%
  • Citadel Investment Group 94.8%

Total Avg Compensation

May 2024 Hedge Fund

  • Portfolio Manager (9) $1,648
  • Vice President (23) $474
  • Director/MD (12) $423
  • NA (6) $322
  • 3rd+ Year Associate (24) $287
  • Manager (4) $282
  • Engineer/Quant (71) $274
  • 2nd Year Associate (30) $251
  • 1st Year Associate (73) $190
  • Analysts (225) $179
  • Intern/Summer Associate (23) $131
  • Junior Trader (5) $102
  • Intern/Summer Analyst (251) $85
notes
16 IB Interviews Notes

“... there’s no excuse to not take advantage of the resources out there available to you. Best value for your $ are the...”

Leaderboard

1
redever's picture
redever
99.2
2
BankonBanking's picture
BankonBanking
99.0
3
Betsy Massar's picture
Betsy Massar
99.0
4
Secyh62's picture
Secyh62
99.0
5
GameTheory's picture
GameTheory
98.9
6
CompBanker's picture
CompBanker
98.9
7
dosk17's picture
dosk17
98.9
8
kanon's picture
kanon
98.9
9
Linda Abraham's picture
Linda Abraham
98.8
10
bolo up's picture
bolo up
98.8
success
From 10 rejections to 1 dream investment banking internship

“... I believe it was the single biggest reason why I ended up with an offer...”