By comparison, the HFRI Macro Total index returned 8.99% in 2022, according to HFR, the research firm tracking the global hedge fund industry.
In an interview with Pensions & Investments, Mr. Tropin shared what he sees for 2023, and what helped the firm's positions last year. The conversation has been edited for length and clarity.
Q: What's changed about the markets today? A: If you look at 2010 to 2021, equities had an enormous return over that 11-year period, largely fueled by stimulus from central banks, the (Bank of England), the (European Central Bank) and the Fed. It was a terrific time to be an investor in beta. You did well if you bought every dip in the stock market. That changed a lot in 2022.
Q: Last year, you successfully predicted the Fed would hike more times and more quickly than everyone else on Wall Street. How?
A: In the second half of 2021, people thought the Fed would hike only 25 to 50 basis points in 2022. The Fed was still in QE mode. Then the Fed realized inflation was getting way higher than they were comfortable with, had to shift gears and delivered 350 basis points of hikes.
Our economists did a very good job of moving from consensus forecast to hawkish. That was helpful to some of our traders in shorting fixed income.
Q: Where do you see the fed funds rate this year or next?
A: The market thinks we will peak at 5.25% or something like that in September. A different question is: Will we stay there a little longer than people would like? People were expecting cuts in the last third of this year. Those expectations have evaporated.
If you look at the start of the hiking cycle, the Fed delivered 350 basis points of hikes instead of 100. The BOE, the ECB and Fed want to really be convinced that inflation is lower than it is now.
Q : Can you explain the historical magnitude of 2022 rate hikes?
A: The best way to think about the period July 2010 to July 2021 is that the ECB, BOE and Fed over 11 years made 13 25-basis-point hikes. In 2022, we saw the equivalent of 40 25-basis-point hikes in one year by three central banks. That created a really constructive backdrop for macro hedge funds and continues to be interesting for what we do. We'll see a lot of volatility and a lot of opportunity.
Q: Why did macro hedge funds outperform compared to other strategies last year?
A: We were fortunate and grateful to perform at a time where traditional assets had a tough year. The traditional 60-40 portfolio had its worst year since 1937. So to be able to achieve compelling results in an environment that was not very good for our clients is gratifying for sure.
Q: What are you hearing from pension funds and plans now?
A: Institutional investors are interested in macro in the current environment. They're very realistic that we may not have the results in '23 that we had in '22. But they will be compelling enough for it to be a valuable allocation in the portfolio. One reason: Macro funds aren't correlated to other hedge funds or a 60-40 portfolio. If your macro manager does good risk management and generates good returns, then it's very diversifying.
Q: How did your experience help, for instance, working at John W. Henry & Co.?
A: In 1982, I joined Dean Witter to take over their fledgling hedge fund practice. I was there for seven years. In 1989, I joined John W. Henry's firm as CEO and ran his firm for four-and-a-half years. In 1993 we parted company and I was fortunate in that I had a long relationship with the Paul Tudor Jones organization, and he encouraged me to start my own hedge fund with him as a strategic investor. In July 1994, I started with proprietary capital, my own and Tudor's and we remain close friends to this day. He's still an investor.
Q: Anything you are now do differently?
A: In the early days of our industry, markets weren't as efficient. The trend-following trading systems I invented in 1993 and 1994, they're still doing well, and it's good for trend following. We want so many more sources of alpha than just momentum-based trading. So we've worked really hard at designing different ways of generating alpha than just momentum.
We began doing discretionary trading in 1998, and today it's one-third of our assets, or just under $6 billion. We've also worked very hard at building fundamental quant models that use other inputs, such as value, carry and fundamental data, all those different signals. We have Graham Quant Macro, which has a very nice returns and is about 60% to 70% correlated to trend following.
Q: What are you forecasting in energy, metals and currencies?
A: In '22, one highlight was the dollar got really strong. It rose 20% to 25% against a basket of currencies. Right now the dollar's in a little bit of a trading range. Rates in the U.S. are higher than European rates. The perception in the market is that the Fed is going to start cutting in the last third of this year. If that turns out not to be true we may see some dollar strength again. But right now we're in a trading range. Our positions in the dollar are just slightly long.
We're slightly long gold, but it's been kind of unimpressive. If there was ever a year you wanted gold to perform, it was last year when we had the highest inflation in 30 or 40 years. And gold went up a little. It's a bit of an underperformer.
Energy's come off a lot of highs in the third quarter, but I'm still favorably inclined to energy.
Our green policies on a global basis are such that there's not a lot of oil and gas development in the U.S. We need green policies, but it creates a constructive backdrop for energy prices.
And some of the supply bottlenecks will clear up, but they haven't yet. We did have a very warm winter in Europe; that was helpful. I'm friendly toward the price of energy at this time. Prices could move up 10% to 15% from here.
In 2022, we had rates go up quite a bit, we were short fixed income, short equities and long the dollar and commodities. So we did well. A strong combination of positions. Now there continues to be volatility in all those markets. At the moment, we're at fair value for the dollar but I think that will change.
Q: Why is Japan on your radar?
A: What's going on in Japan is, they continue to cap on 10-year bonds at 50 basis points. A lot of people think they'll have to capitulate and let interest rates move higher. Their inflation is at a 40-year high. That's an interesting market to keep an eye on. If the central bank capitulates, the Japanese bond, the dollar-yen and the Nikkei would sell off.
Q: What's your warning to investors about U.S. equities?
A: I wouldn't be too confident as an investor. We had 350 basis points of hikes last year and another 25-50 basis points this year. That's going to cause the economy to contract. Equities aren't that far from their highs at the end of 2021. So maybe we're 10% to 15% off the highs. But for example, the FTSE, the U.K. market, is at its all-time high. That seems to me a mispricing if you think the tightening by all three central banks simultaneously will contract the global economy.
Q: Exogenous shocks might be more significant, then, such as China reopening? War with Taiwan? Dirty bomb in Ukraine?
A: It's all of those. The most relevant one is what happens in Ukraine. We continue to see no resolution that's obvious. You wonder how desperate Putin could get, whether China continues to get more aggressive with the U.S. These are low probability tail events. I don't predict any of these things. But I also wouldn't be so complacent about them.
A more relevant question is: What happens in the 2024 race for U.S. president? That to me right now could have a profound effect on markets. Look at the effect on central bank policy. The Fed tries to be neutral to who's in office. (Former President Donald) Trump put a lot of pressure on (Fed Chairman Jerome) Powell to cut rates. And he's a pro-business guy. Who knows if Trump gets the nomination. But that's an example of how it could affect markets we trade.
Q: If the GOP nominee wins the White House, what does that mean for markets?
A: It's too soon to say. It's going to create uncertainty, which is helpful in that as a macro manager, we like to see markets moving. And uncertainty is a catalyst for that. If you're an interest-rate trader, and rate policy is on hold, there's less to do, than when there are lot of hikes or cuts. We can't say with confidence we get the move right. But the opportunity set is profoundly greater when central banks are on the move.
Q: What's your take on markets like cryptocurrency that collapsed last year?
A: One concern I had...was crypto was so volatile. I had a hard time understanding how it could be an alternative currency when it had annual volatility off the charts. There were a lot of aspects about the infrastructure I find interesting — blockchain is a technology that has quite a bit of legs to it.
We trade crypto futures in a very tiny way, with no impact on our performance. We don't have an edge in crypto. I've learned if I don't have an edge, stay out.
Top level, investors over the last decade or so have been very fortunate to have terrific returns from traditional investments and hedge funds, and have outsized results compared to previous market cycles, say, between 1990 and 2000, or even the weak markets of 2000-2002. We just had an 11-year period, because of all the stimulus, that was unusually good. Investors have to be more sophisticated going forward. Macro is one of the opportunities for investors to get a source of alpha that's typically uncorrelated to equities and fixed income.