Around the World With Balestra's Melcher

Among hedge funds, global macro managers take long and short positions in stocks, bonds, currencies and commodities, based on broad economic bets that may or may not pay off. With a 13% return after fees at Dec. 2, New York based hedge fund Balestra Capital Management is a winner in this often-risky field.

James Melcher, Balestra's founder, spoke to TheStreet.com last week about his investment philosophy. (As always, any hedge fund's positions are subject to change without notice.)

What makes you different from other macro hedge funds?

Some define global macro managers as just players of themes in interest rates, commodities or currencies, but not as stock-pickers. We are also stock-pickers. We invest in groups of equities and of course we use ETFs, futures, and even mutual funds if we want. We go anywhere in the world to implement strategies. Our only limited factor is risk.

Does it mean that you are running a low-volatility strategy?

Not necessarily. Sometimes if you accept higher volatility, you can actually get a better risk/return ratio. To rely heavily on volatility, I think, is a mistake. Take Long Term Capital in 1998. There was nothing in their volatility figures that would have predicted a risk of that sort. We look at volatility without relying on it. We have at times plunged into very high volatility situations while actually controlling risk.

Give us an example.

In 1999 and 2000, we entered into two groups of equities with extremely high volatility. We went long some small and large high-technology stocks. The volatility was high on the upside and we knew that when the bubble burst, they'd drop very sharply, maybe 50% to 80%. We sold short small Internet stocks, which also had extremely high volatility. If the bubble burst, we thought our shorts would drop 90% to 100%. So we went to a well-hedged position. We did have very high volatility, but during that period of time, we were hedged. In 1999, despite being long and short -- roughly market neutral -- we were up about 100% after fees. In the first quarter of 2000 we were also up very much. When the bubble burst we gave back some of our gains, but over the entire year, we were still up 25%, because the system of long and shorts worked. We were in a hedged position that produced 150% gains for a portfolio in two years and yet we were condemned because we dared commit the cardinal sin of having volatility in any given month. Institutional investors are trapped by their own restrictions.