A New Kind of Global Macro

This is going to be kind of esoteric because I'm holding my cards close to the vest.

Imagine:
Since the entire basis of global macro is risk management, what if we could put portfolios together one risk factor at a time? Wouldn't that be interesting? Risk exposure is the beginning and the end of all global macro strategy. So why wait until the end to integrate it? It would be much better to bet on the risk factors right off the bat? Why focus on certain commodities, currencies, and corporation's securities (or the respective derivatives)? That was never the point of global macro. We care about capitalizing on macroeconomic changes anyway. Why get exposure to those changes from a few instruments when you could get right to the source, and just buy the factor itself?

It's simpler. It's more efficient. It's more potent. It's better diversified.

So the answer is to construct portfolios consisting of nothing but a few uncorrelated risk factors selected in whatever relative portion desired. The method driving the prediction of risk factors is not the issue. That is for another time. What we're concerned with is portfolio allocation once the decisions have been made.

And best of all? Portfolio optimization is easy. The risk factors are approximated by baskets of many instruments, and the instruments each have a covariance with each other. But that has already addressed by principal components analysis. We can merely treat each factor as an instrument to be bought. (This is reasonable--because it is like buying a stock, which is a basket of risk factors, only these ones have with non-zero sensitivity to only one risk factor.) Once we have bought these baby, de-facto 'stocks,' we realize that they have no correlation at all. Thus, the terms inside the first sigma in the Markowitz Mean-Variance model are eliminated, and the second one is easily maximized by investing the most money where the highest return is expected. This is similar to setting our risk adversity parameter to zero, (though we have done nothing of the kind,) since it is now trivial.

This may seem dangerous, because the allocation weights are not constrained, but a rule can be added separately, allowing a maximum position size in any given risk factor, as well as a maximum position and/or maximum portfolio variance. On top of that, we can use VaR systems and stress testing like any global macro fund would.

The exact method for predicting factors varies considerably. There are several approaches that could work, including the John Paulson approach, the Soros approach, and the Robert Frey approach.