Thematic Allocations Using ClearMacro Theme Ratings

by | Feb 2, 2020

This is a case study demonstrating how investors integrate their own views with ClearMacro investment frameworks in order to generate alpha.

The Case: Going underweight exporters to play the protectionism/trade wars risk, initiated in April 2018, and still running.

 

 Summary 

  1. Performance: Generated 14% net gain and 10% alpha over 21 months.
  2. Conviction: Dynamic, linked to ClearMacro’s theme framework, in order to estimate probability that the theme will influence market returns over the next 12 months.
  3. Differentiation: Systematically integrates human judgment with our objective ClearMacro framework, compared to traditional approach of qualitatively evaluating investment themes. While concern around rising tariffs was a well-known risk in April 2018, applying this framework enabled investors to more objectively calibrate the size of the alpha opportunity.
  4. How: By constructing a framework that allocates dynamically to the theme based on the real-time alignment of investor view in conjunction with ClearMacro’s thematic framework, drawing on 56 ClearMacro signals and 1 million+ data points.

 

How is our approach different to the way investors typically invest in themes?

Bottoms-up investors often rely on macro research from sell side firms, which is typically unstructured and unaccountable.  Whereas top-down investors tend to get wedded to a dominant macro idea and often miss adjacent information and market pricing signals.

Instead, we believe it is better to integrate qualitative and quantitative information in a structured and transparent framework designed to generate investable conclusions. Currently the framework is limited to themes that ClearMacro has identified and written about, however users will soon be able to be apply the framework to ANY theme of interest.

The framework generates theme ratings “built up” from 3 criteria:

  • How likely is it that the theme will drive market returns over a horizon that most investors care about, in this case the next 12 months? This judgment-based conviction rating is based on a set of pre-identified signals curated by ClearMacro for relevance and credibility (based on back-test performance results).
  • How much has the theme already been priced in by market participants? This pricing rating is systematically extracted from current market pricing.
  • Is the overall macro outlook a tailwind or headwind for the theme? This macro rating is objectively built up by mapping a theme implementation basket to ClearMacro’s investment ratings.

 

Why should investors care?

The potential to generate alpha by investing in a theme is notoriously difficult to quantify as the underlying thesis is frequently qualitative, and relevant time frames are often far in the future. ClearMacro‘s approach is to mitigate this challenge by linking the most credible data to a set of critical analytical criteria, which when integrated with the investor’s own expert human judgment allows them to more efficiently identify which themes are worth investing in.

Bottom line: our framework helps you capture more of a theme’s alpha potential by ensuring that you tilt your thematic exposures to themes that:

  • Are highly likely to drive returns in the near term.
  • Are not already discounted by the market.
  • Have overall macro drivers working in their favor.

 

An Example

In March 2018 we released a note recommending that investors go short the equity indices of export-sensitive countries against an overweight in MSCI World.

The idea was premised on a human judgment (in this case ClearMacro’s, but could easily have been a client’s) that the potential for an escalation in trade tensions was very high, and that the economies of significant exporters, such as Hong Kong and Singapore, would be hurt relative to less open economies. Key signposts (ClearMacro signals) were identified in order to dynamically articulate a conviction rating derived from this judgment call (would the theme influence returns in the next 12 months?)

The framework provided a Tariff Vulnerability Index that, when used to identify a “theme implementation basket” generated a pricing rating (how much alpha is left in the theme). For example, in March 2018, when our note was released, the pricing rating concluded that the theme was 0% priced in by investors, but by the end of Q4 2018, this had risen to around 90% as export-sensitive equity markets strongly underperformed.

Pricing Rating: dynamically tracking how much alpha potential is left in a theme

Finally, we objectively linked ClearMacro’s Short-Term Investment Ratings to each member of this theme basket to generate a macro rating for the theme – we objectively analyzed that data and determined if the macro outlook was a headwind or tailwind for the theme’s performance. For example, the basket was heavily short Hong Kong equities (reflecting the fact that Hong Kong was a big exporter). The collapse of our short-term rating for Hong Kong in H2 2018 generated a very bullish macro rating for the theme; it signalled that the macro environment in Hong Kong was highly likely to deteriorate and that this would therefore benefit the performance of the theme basket.

Finally, these 3 analytical criteria (conviction, pricing and macro) were aggregated into a dynamic theme rating which the user could systematically map to a capital allocation decision.

The combination of human judgment and systematic, objective conclusions drive capital allocation to the theme as they align / diverge. 

Summary and Performance

Using this framework, the user would have realised a net gain of 14% and alpha of 10% over the 21-month holding period (excluding transaction costs).

Performance Tracker: Protectionism theme allocation decision

These thematic insights could also have been used at CIO, PM or analyst level to dial up / down EM portfolio risk / overall beta levels / trade-cycle related exposures in their portfolio. ClearMacro currently has several other themes running live on our analytics platform, ClearENGINE, and we can also work with clients to upload their own themes. 

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