What has been at the vanguard of thinking in finance is the breakdown of returns into their constituent parts or risk factors. Finance has moved well beyond market beta. The primal breakdown for a portfolio is not returns by asset class but returns by risk factors. Some have criticized the current situation as a factor zoo; however, even factor excesses do not change the fact that factorization is the paradigm used more and more by investors.

There are many factors and many assets to map with factor weighting. The sheer size of the problem lends itself to computerization and data mining. The analyst’s role as a storyteller is diminished when a stock can be described through a set of modeled factors. Investors now buy risk premia, not stories or names. Individual names are just the means to the end of gathering beta risks. Smart beta is just the realization that if factors can be used to describe stocks, they can also be used to weight stock portfolios. This may be smart or just the outgrowth of how the finance world is being viewed.

Factors can be classified into two main categories: micro factors which are asset-specific and macro factors which are related to macro events like the business cycle or changes in rates and credit availability. Hence, the type of hedge funds chosen by investors is based on whether the manager focuses on micro or macro factors.

So what is the essence or purpose of global macro? In this new factor world view, global macro investing focuses on broad economic factors that can be dynamically adjusted to generate excess return. Since factors move in and out of style or importance, the macro investor tries to find ways to exploit these changing weights.
The issue is which factors are relevant for global macro investing. We are aware of the criticism of factor timing, so we must be precise about what factors we discuss. Global macro has the overarching theme that the manager is trying to identify global business cycles or growth recessions that spill over to the behavior of specific asset classes. Along with the business, credit and financial cycles impact asset classes around the globe differently. The growth/inflation mix impacts policy choice, which feeds back on asset classes. What makes global macro so difficult is the low predictive skill of managers at forecasting these macro factors.

The difficulty with forecasting macro factors calls for managers to stay diversified, follow market trends, and take high probability tilts to specific factor opportunities. The poor performance for global macro is a function of the high uncertainty associated with the major macro factors. There is no smart beta in global macro if the macro factor directions cannot be identified. Global macro returns will only improve if the degree of uncertainty concerning growth, inflation, and liquidity falls to levels that allow bets to be identified and managed.

The better performance with managed futures programs is based on the core focus on momentum and diversification, not fundamental macro factors. Managed futures captures macro events through the movement in asset prices, yet if there are no string trends, there will be only limited opportunities.