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The views expressed are those of the speaker(s) and are subject to change. Other teams may hold different views and make different investment decisions. For professional/institutional investors only. Your capital may be at risk.
Episode notes
Head of liquid alternatives and hedge funds, Mark Sullivan, and investment director of diversifying strategies, Chris Perret, share their views on why the multidimensionality of macro investment approaches may help provide investors a smoother path forward amid an increasingly uncertain macro and geopolitical backdrop.
1:50 Career paths
5:10 Major shifts in the macro environment
8:20 Influence of government policy on markets
10:50 Effect of US election cycle
12:10 Japan’s new reality
14:40 Key to success for macro strategies?
16:40 Geopolitical risks
19:30 Dimensionality in the investment process
21:00 Importance of talent development
25:20 Why lean into macro now?
Transcript
MARK SULLIVAN (Cold Open): And really the goal is that we want to have a lineup of portfolio managers and strategies such that in any state of the world, there’s a subset of them that should have a good opportunity set and be able to generate attractive outcomes.
THOMAS: 2024 is nearly half over, and economically speaking, things haven’t unfolded quite the way many market watchers and policy makers expected. Growth has surprise to the upside. Inflation remains stubbornly above target. Job growth is stronger than anticipated. And investors are bouncing between interest rate pessimism and corporate profit optimism. All of this is set against a tricky macro backdrop of heightened geopolitical risk and critical elections in the US and around the world. So I think it’s safe to say that investing with a macro lens requires the flexibility, knowledge, and skill to exploit this multi-dimensional landscape. So joining me today to explore this fascinating topic are Mark Sullivan, head of liquid alternatives and hedge funds at Wellington and lead portfolio manager of a macro long/short approach, and Chris Perret, investment director for our diversifying strategies practice for the firm. Mark, Chris, I’m really excited for this conversation, so welcome to Well Said.
MARK SULLIVAN: Thanks for having us.
CHRIS PERRET: Nice to be here.
THOMAS: All right, so before we dive into the meat of our conversation here, I’d like to ask each of you a bit about the path to your current positions, how you got here. So Mark, let’s start with you. You began your career at Wellington as an undergrad 25 years ago -- I just gave away your age there -- and now you head up the firm’s hedge fund platform. So it seems like your career path has also been multi-dimensional and non-linear. So how’d you get from here to there?
MARK SULLIVAN: So I was very fortunate to start my career at Wellington right out of undergrad and joined the firm in an analyst program that had a rotational aspect to it. And so after my first year doing a more generalist role, I was able to rotate into the fixed-income quant area, and then within there start working with the global fixed income team, which created a lot of opportunities for me. Originally I started focusing on a risk and ultimately developed the risk-management process that really underlies what we still do today on the platform, From that point I started working as a portfolio manager, focused on interest rates and currencies, and really ran one of the strategies doing that for 11 years. And then following that team leader’s retirement in 2016 I took over the team leader role for the macro platform, and shifted my focus at that point to be more, focused on manager selection and allocation, the risk oversight of the portfolios we were running, and also the strategic planning for the team and the platform. And then in 2020,ollowing a review of the alternatives capabilities at the firm, the CEO at the time asked if I would take on additional responsibilities for, the strategic oversight and strategy for the hedge fund business here at, at Wellington.
THOMAS: So, Chris, same question to you. What’s been your path?
CHRIS PERRET: I started, like many, on a trading desk at a bank. And I think I quickly learned that I was much more interested in the client angle of this business that’s really important. And so made a transition within the company I was working for at the time to this really interesting role called product. And what I loved about it was that I still was very interested in the investment side of this business, right, and working with really smart, talented people, but at the same time, again, really had this kind of desire to, to get more close to the end client. In 2010, Wellington offered me an opportunity to come work, importantly, with Mark. Initially it was more, again, driven off the fixed income side and really helping scale that business post-global financial crisis, and over the last few years have been asked to really help out on the hedge fund side. How do I support Mark and the team? Really getting the product rolled out as the way it’s been defined here is to be an extension of the investment team, and so that essentially means, one, being the proxy in front of our end clients, or end LP’s, but then also, importantly, to get involved in a lot of the checks and balances of the organization, right? And importantly, there, thinking about risk management integrity in terms of what we’re telling clients: are we actually doing that on the tin? Things like that, um, really make this a very holistic role, and it’s something I really enjoy.
THOMAS: So you get to answer all the tough client questions?
CHRIS PERRET: I get to answer all the tough client questions, yes, good and bad.
THOMAS: It’s funny, my role here -- I’m on the investment side, but I also have a pretty prominent client in position as well, and I really like those conversations as well, and the blend of the internal/external.
CHRIS PERRET: I think it actually makes you smarter, right? A lot of times, clients will actually tell us, it’s our first time to hear that, or it’s an opportunity for us to learn more. So I think that’s a really important part of the job.
THOMAS: Totally agree. All right, let’s shift to our topic of interest. Mark, we’ll go back to you here. So Wellington’s team leader of macro research strategy, John Butler, someone we all know well, he said recently that these are the times when macro volatility, uncertainty, and the distribution of potential outcomes is really wide, and the opportunity set, because of what central banks are doing and saying, has just exploded. So John’s referring to the risks and opportunities associated with policy and potential policy missteps, but can you elaborate on that?
MARK SULLIVAN: I’d be happy to. I’ve been investing in macro markets for well over 20 years at this point and really think that the period we’re in is a really exciting and differentiated, period for, for the world and for macro investing. And, and the reason I say that is that, -- we are of the view that we are in the midst of a regime shift, and that a lot of the secular trends that underpinned the period of disinflation that we experienced really from the ‘80s on until very recently have largely come to an end; they’re actually turning the other way. And then that overlaps with something you talk a lot about, which is this concept of great power competition and, and how the relationship of China in particular and the rest of the world has gone from one of bringing that economy into the global economy, into more of a containment strategy. I think that was exacerbated by, sort of the lessons of COVID, where for a long time, most economies in the US in particular were really motivated by profit maximization, which meant that putting your supply chains into the cheapest possible places made the most sense. What that didn’t account for was the potential of a pandemic like COVID, you know, really challenging that model, right? In terms of is it really worth it to have all your supply chains so far away? So there’s a lot shifting on the supply side, and that overlaps with the debt levels that we see as well as the policy makers. And again, I would add to John’s comment that it’s, it’s both the central banks, but also the fiscal authorities that are particularly important to pay attention to, as that intersects with the amount of debt they have. And so the conclusion from that for us is that we, we think we’re in an environment where volatility will be higher of growth and inflation, which will mean policy itself will be more volatile.
One of the other things that COVID sort of brought to life was actually a concept that Trump first brought to the fore, which was really a response to the rise in populism, which is to not just run easy monetary policy and tight fiscal. Trump was like, we’ll just do both. And if you remember back in 2016 into ‘17, that the U.S. economy started operating a very different way than the rest of the world, where we started to see growth and accelerated inflation that led to an actual Fed hiking cycle. Fast forward to COVID, the response to that was, was rightfully a big fiscal response. The takeaway, though, is that is unlikely to go back in the box. That I think you see now we’ve transitioned from monetary policy being the first port of call every issue to one where actually fiscal policy is the first port of call and monetary policy is there supporting that.
THOMAS: Let me underscore something you just said, because obviously it’s music to my ears. The changes that we’re seeing in the geopolitical environment are profound. I do think every policymaker who I talk to is really emphasizing national security over economic efficiency. So the underpinnings of globalization are changing in dramatic and structural ways. And I would completely agree, I think that’s leading to a much more differentiated set of outcomes, and differentiation is good for markets. It’s allowing us to find winners and losers. And so, you know, investors that can capitalize on these great shifts tend to do well. But I’m curious, you know -- you mentioned the Fed. How do you think about the potential for policy error? But how does that flow through your sort of thought process?
MARK SULLIVAN: This is challenging environment to forecast, and I think you see the Fed struggling with that and as a result, they’ve become shorter-term-focused, and you could suggest a lot of their sort of rhetoric has shifted more or less on a trailing three-month input of data, particularly inflation, but also the labor market. And so I think the chance of policy error here is high especially when you combine it with the, the fiscal side. It’s certainly something the Fed is, is trying to thread the needle on. And then the other thing I would suggest is important to pay attention to is the asymmetry of policy. In our opinion it’s pretty clear that the central bankers are very asymmetric in their approach, and that they seemingly are willing to take risk with inflation and not take any risk with financial stability or downside to the labor market. So if you look at the response to the regional banking issues that we saw in March of last year, they were very quick to cut off the credit-tightening tail. I think it is reflective of central banks, but also policy makers. One of the results of the Russia-Ukraine conflict was the impact on energy markets. And the response to that from the European governments was to use the government balance sheet to insulate the household sector from the impact of the energy shock. Really trying to cut off that tail. And I think until the bond market start to push back on that, that is likely the course that we’ll see here, is that the downside will be cut off at the risk of future higher inflation. That’s one of the reasons why we think bond markets globally are likely underpricing term premiums.
THOMAS: Let me throw another wrinkle at you, a Fed wrinkle here, which is of course the U.S. election. I’ve heard some people speculate that the Fed may be reluctant to make too many moves because they want to maintain independence, they didn’t want to appear overly political. So do you accept that, first of all? And, given that this could be a pretty narrow policy decision window, what are you watching from an investment perspective then?
MARK SULLIVAN: I do accept that the Fed really wants to be viewed as independent so that they can act independently. I think, you know, for people like Chair Powell, you know, a lot of what they focus on and, and talk about is, is the legacy. They want to have a strong legacy of being a good steward of Fed policy and ultimately delivering on the dual mandate of the Fed and, and really trying to be independent of the influence of politics.
THOMAS: And that served the Fed well over decades.
MARK SULLIVAN: For sure. Now, I do think central bank independence is under threat in many jurisdictions, both explicitly and implicitly because of the amount of debt and the concept of fiscal dominance starting to take hold. And so, within that, as it relates to election itself, I do really think the Fed will be guided by what they think the correct policy is for the economy.
THOMAS: They’re real people. They live in the real world, right?
MARK SULLIVAN: Yep.
THOMAS: They’re, they have those same dynamics. All right, so let me switch gears a little bit on you, Mark, is Japan, which just raised rates for the first time in almost 20 years. It’s clearly celebrating the return of inflation. So what do you think investors should understand about the future for the Japanese market?
MARK SULLIVAN: Yeah, Japan is a fascinating situation. I think one way to think about what’s going on in Japan is an example of the impossible trinity, where, the concept is that you can’t have a free-floating exchange rate, free movement of capital, and full control over your monetary policy all at the same time. And they, I think, are reaching a point where they’re going to have to choose more clearly in terms of what they actually want to control. And the reason for that is that for a long time Japan has struggled with disinflation. But it is pretty clear at this point that they have come out of that. And one of the themes that we’ve been focused on is the policy settings and the dynamics of that economy were set up in a way that nominal growth was likely to be higher than it had been in the past and higher than the market is expecting. And so there have definitely been opportunities to be long of assets that are going to do well when nominal growth performs in the economy. Now, as that’s occurred, inflation has obviously gone up. The challenge is that the currency market is well aware of that, and dollar/yen has been on a significant and multi-year trend of depreciation, and is now getting to the point where it was part of the solution but now potentially is becoming part of the problem as the potential for imported inflation starts to go up, especially if energy prices continue to find good footing and, and move higher.
THOMAS: So that balancing act gets trickier.
MARK SULLIVAN: Very tricky. And I personally think they’re getting close to the point where they need to decide between a stable currency and a stable bond market. And as that occurs, one of the things that we’re watching carefully for are indications that they’re going to incent or, through regulation force, their domestic savings institutions to hold significantly higher amounts of JGBs. And that will lead to the stabilization of the currency and potentially even some appreciation. That’s a hard thing to pull off. So there’s certainly going to be room for error and they are dependent on what happens in the rest of the world.
THOMAS: Yeah, it doesn’t sound like a fun job or one that we’d want to be applying to anytime soon. So Chris, you’ve been at this for a while, as you said before. Now, with the benefit of market cycle wisdom, if today’s uncertain conditions are those in which macro approaches potentially perform well, what do you think is the key here to success, given that the rest of the market vastly prefer certainty over the kinds of uncertainty that we’ve been talking about today?
CHRIS PERRET: Yeah, I think the alternative industry and liquid strategies in particular -- there’s been a very clear shift in wanting to have that certainty, right? Hedge funds, in particular in a lot of ways used to provide the ability to capture a lot of the upside, and importantly, were also designed to really ensure that if there was an event like a COVID or something like that, that, they would also provide insulation or a hedge. They’re called hedge funds for a reason. But importantly, I think, as time has progressed, the tolerance for volatility around those two outcomes has gone down, and that clients want that certainty. And so one way to ensure that or at least have a better shot at achieving outcomes again of providing consistent positive outcomes while at the same time hedging downside is to diversify. . But at the same time, diversification only works if you’re intelligent around how you allocate out capital. Finding different styles of investing in those type of environments, and combine together in an intelligent way from a capital allocation can lead to that more consistent positive outcome, which is what people want in most normal environments. It’s hard to do in practice, but it really, as a first starting point, this idea of dimensionality or being open to slotting in different types of strategies that can perform in different environments, and then, importantly, giving the strategies the latitude to invest and take risk when they find opportunities, but also be equally open to the idea of capital preservation when they’re not finding opportunities is really important as well. So I think this is the path, certainly, forward in the industry is this idea of dimensionality and, and really focusing on diversification.
THOMAS: So I’m going to stick with this theme of uncertainty here. Obviously, geopolitical risks are part of the mosaic now. Mark, you mentioned that before and it’s certainly true for macro investors. We talk a lot about this on this podcast and across the firm. I work to make sure that my geopolitical analysis is part of the investment input for every team here at Wellington. So from the macro perspective, do you think the role of geopolitical considerations in the investment decision-making process and risk-making process is a bigger factor? And what’s the practical aspect of that?
MARK SULLIVAN: Yeah, I promise I wasn’t paid off to say this, but, yes, I absolutely think,
THOMAS: Such the right answer.
MARK SULLIVAN: It’s a bigger factor, for sure. And again, one of the ways I would maybe bring that to life, right, is for a lot of my career, I would characterize markets as being driven being really a free-market capitalist regime, right? And, and what that means is that, in practice, that a lot of the capital allocation decisions that were happening in the economy are happening through the decisions of firms like ours, right? Where clients are giving us money; our job is to determine, within whatever the objectives are of the best way to allocate that capital into the economy that generates attractive outcomes. And really that’s, in a lot of ways, a profit maximization exercise, right? We talked a little bit about how that sort of led to the outsourcing of so many of the supply chains to cheaper jurisdictions, things like that. You fast-forward and put that into the context of geopolitics as we see it today, and I think it is likely that the government is going to play a much larger role in the capital allocation process within economies. And I think you see that already in things like the CHIPS Act the Inflation Protection Act, where the government is really using its role in the economy to have a much more visible hand of why certain capital allocations and investments are happening that are not strictly profit maximization. They’re really including the geopolitical lens in how they’re thinking about that. And that’s really important, to think about and understand. Because, again, it will lead to a different set of outcomes than you would get if you were just, again, strictly looking at it from a profit maximization perspective.
THOMAS: Yeah. That’s something, obviously, that I spend a lot of time with. It’s this focus on strategic sectors. These industries that matter in this great power context. The United States and its allies want to win these industries. China and its allies want to win these industries. We’re moving into a period where we’re going to have more protection and promotion of these strategic sectors. And I agree. As you say that’s a big shift in the policy environment. It was US foreign policy to promote globalization for decades. That’s not so much the policy anymore. It’s more about, how do you get a handle on these key sectors going forward? Now, Mark, Chris mentioned earlier this concept of dimensionality and how important it is to hedge fund industry. How does that manifest for your team? In other words, what’s the relationship between dimensionality, a global investment team, a multi-asset research platform, and of course risk management?
MARK SULLIVAN: Philosophically, in terms of how we have developed our own investment process, how we think we can operate in this environment that we’ve been describing, we think it’s really important to have a diverse set of strategies that address a number of different opportunity sets within our broader opportunity. And really the goal is that we want to have a lineup of portfolio managers and strategies such that in any state of the world, there’s a subset of them that should have a good opportunity set and be able to generate attractive outcomes.
THOMAS: A diversification theme.
MARK SULLIVAN: A diversification theme, right? Now, diversification is, it’s a simple concept, it’s just hard to do. But really there are two simple things you have to be able to do. You have to find things that are good in absolute terms, right? They’re good at making money or good at generating returns. But two is that they are independent from each other. And the reality is it’s hard to find both of those things. And macro, to a large extent, has less degrees of freedom when you really look at it in terms of the things that you can do. So we put a lot of time and effort into really trying to be careful about ensuring that we have sufficient dimensions present so that we can achieve our goal of having the subset for any environment that’s working.
THOMAS: So Chris, what Mark just said requires talent, right? It’s hard to do. You need to find the right people that can figure this out. And I think macro investors today, as we’ve been detailing, have an incredibly challenging, complicated job. So in such a competitive environment for investment talent today, how do you attract and retain that talent? I mean, what are you looking for? What are the key skills, and why do you say that?
CHRIS PERRET: I think the first thing to highlight is that there’s no silver bullet. I think for us this idea of embracing people that come from different backgrounds, having different schools of thought, and harness this concept of dimensionality is critically important for us. As a result of that is when we’re sitting across the table from somebody and, and interviewing them, if their number one concern is money, those people tend to not necessarily be the individuals that we would want to embrace. We’re not looking for a pack of lone wolves, we’re looking for a team, right? And, and that our belief is that a team will beat a pack of sole individuals. And so the value proposition that we really try to entail is to say that people that are out there that are really talented macro investors, in a lot of cases, are looking for more than just money. They’re looking for a platform that allows them to be their best. They’re looking for a culture and an ecosystem that allows them to collaborate with people across the organization. And I think that’s one of the advantages that we have here at Wellington, is that we are a large organization. We have a lot of people that have a lot of knowledge about a lot of different concepts and as macro people, we’re always trying to kind of find that edge.
THOMAS: I find that macro thinkers tend to be like magpies, taking little bits of information, putting it all together, examining each piece. But you have to collaborate and you have to talk to people and you have to be comfortable with that in order to maximize the investment benefits there.
CHRIS PERRET: Yeah, Mark, do you have any other comments on that, as well? Because I know you meet a lot of, a lot of PMs these days.
MARK SULLIVAN: Yeah, sure. So there, there’s two points I can think I’d, I’d add to that. One is, is just a starting point of Wellington in terms of what I think the edge of the firm is at a really high level, which is that Wellington, I think, is fairly unique in having built what is a global and highly integrated and diverse investment platform. And one of the things that makes it unique is that it was, it’s all been done organically, and so it’s really carried this culture of collaboration with the growth, and with the diversity. And so that is a critical ingredient to actually taking advantage of diversity. And so one of the things I feel really responsible for when it comes to talent is really trying to make sure that we identify people that meet two simple criteria. One is a demonstrated skill in some part of the opportunity set we care about, but two is, people that really believe and can see being part of Wellington will actually make them better as an investor and will therefore contribute to making the investment platform better as well. And Thomas, as you said, like, in macro investing, it’s really important to connect dots across a lot of different disciplines. And one of the other really nice things about doing it at Wellington is Wellington has tremendous depth on bottom-up research of the company at sector level. And as macro investors, we tend to look at things top down. And so having the opportunity to collaborate with bottom-up investors really can help us build conviction in things that we think we see top down. Japan would be a great example, where we were able to be early in identifying the opportunity in Japan. And a lot of the conviction we were able to build was through working with our colleagues in the equity side who’ve been investing in the Japanese equity markets for decades. And really asked some questions about, you know, go ask your companies what’s happening with employee turnover? What’s happening with the wage process? And come back and tell us what you hear. And they would come back and they’d say, wow, this is like nothing we’ve seen in our careers. And again, these are people that have been in these markets for decades. And that, again, really helped us gain conviction that something different was going on in Japan and be a bit ahead of the market.
THOMAS: Yeah, I find that to be true in my research as well. I mean, you need to understand the forest, but you need to understand the trees, and you need to understand people who can read the trees, read the leaves. So it all sort of fits together, and I also find that talking to company experts and global industry analysts helps my conviction level in terms of what’s happening in the geopolitical environment, because they, they’re talking to the CEOs and other company leaders and they’re marrying these concepts. So completely agree. Now, this aspect of macro investing also applies to the firm at the macro level. So why do you think active asset managers, including Wellington, are evolving and expanding their macro and alternative offerings? I mean, have markets fundamentally and structurally changed? Is this the driving factor here, or is there something else going on?
MARK SULLIVAN: I think it’s a pretty natural response to sort of the shifts that we see in the asset markets, right? If you look at the period that followed the European sovereign crisis, so we’ll call it 2012 through about 2016, 2017. That was a period of very homogeneous outcomes across most economies, where you had similar growth, very benign inflation, very common policy settings of easy monetary policy, more austere fiscal approaches, and the big use of QE, right? So that became a big policy tool during that period. That turns out to be a great backdrop for asset price appreciation of all kinds. And so that period, the optimal portfolio was risk parity. You basically just wanted to be long all the assets, and if you could add some leverage to being long, that was even better and that worked great. And, and the other side of that is not a great period for active management. It was a big rise of indexing, passive, all those things really did very well during that period. I think as you fast-forward to today, though, you’re in a period where all the things we’ve talked about today are, are front and center, and are a backdrop where I think active management will, will see a lot better opportunity set. But I think another really important piece of the puzzle is that the bond market is not really playing its role that most people are used to. So if you think about how most portfolios are built in their asset allocation, it’s to have, you know, a reasonably large chunk of the portfolio in risk-seeking equity-like assets. And then you have a smaller-but-large portion of the portfolio allocated to the bond market as anchor to weight or the diversifier for periods of equity stress. And for a long time that worked extraordinarily well, right? The 60-40 portfolios worked extraordinarily well. But if you look today, the bond market is not really delivering on either of the things that you wanted it to do. So if you look at trailing total returns on bond indices, they are flat to negative over trailing five-year periods. But more importantly is, is what happened in a year like ‘22, where the diversification benefit that so many portfolios are built to assume is there was not there at all, right? You had bonds and stocks going down together, which made portfolios a lot riskier than people expected. And so I think a lot of that has led people to say, well, if the world’s shifting and the asset markets are not going to give me the same outcomes that I’ve been used to, what are alternatives to that? And so you start to expand into other areas to find either ways to enhance your returns through, giving up liquidity, going into the private markets, or trying to enhance return and improve your diversification through using strategies that have high active share or very active, and that’s where the hedge fund portfolios would land. But I think that’s something that’s going to continue. I think that we’ve shifted away from that period that we saw in the 2012 through 2017 period to one that will really favor more active management and alternative, portfolios.
CHRIS PERRET: If you just look at a year like 2023 where, after, getting a negative print from both your bonds and equities, that I think certainly raised the awareness amongst investors of all types, high net worth all the way to institutions of the importance of this. In some cases, again, the investment and the commitment to increasing alternative allocations was there. But I think also a lot of cases, investors realize that especially that piece of diversification was maybe a little under-appreciated.
THOMAS: Well, you guys are not going to get an argument for me that macro doesn’t matter. So hey, thanks so much, uh, both of you, for spending time with us. Once again, Mark Sullivan, head of liquid alternatives and hedge funds, and Chris Perret, investment director for Wellington’s diversifying strategies. Thanks for being with us.
CHRIS PERRET: Thanks for having us, Thomas.
MARK SULLIVAN: Thanks a lot.
Views expressed are those of the speaker(s) and are subject to change. Other teams may hold different views and make different investment decisions. For professional/institutional investors only. Your capital may be at risk. Podcast produced May 2024.
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Head, Hedge Fund Group
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