During the quarter, the iMGP DBi Hedge Strategy ETF gained 1.77% at NAV and 1.19% at market price versus the Morningstar Long-Short Equity Category benchmark gain of 1.76%.
Performance quoted represents past performance and does not guarantee future results. The investment return and principal value of an investment will fluctuate so that an investor’s shares, when redeemed, may be worth more or less than their original cost. Current performance of the funds may be lower or higher than the performance quoted. To obtain standardized performance of the funds, and performance as of the most recently completed calendar month, please visit www.imgpfunds.com.
Quarterly Review
During January and February, the markets fiercely debated whether the Fed would need to keep hiking rates – not just to further tamp down inflation but to restore its credibility. By early March, the “too hot” camp was winning again: the market expected the Fed to hike 50 bps and peak rates would soon touch 6%. Then on March 9, Silicon Valley Bank (SVB) suddenly collapsed, which kicked off an overnight run on regional banks, and soon the decade-long train wreck at Credit Suisse came to an ignominious end. Something big finally had “broken” and, in the blink of an eye, central banks were back in triage mode – effectively guaranteeing trillions of unsecured deposits and providing emergency credit. Treasuries staged a historic rally and various legs of the inflation trade – value vs. growth, non-US vs. US, Euro vs. yen – sharply reversed. By month end, by some measures the bond market was signaling an imminent recession and 200 bps of rate cuts in the next year or two; stock markets were oddly unfazed and rose as well.
The head snapping shift in the “consensus” view underscores three points. First, we are indeed living in highly uncertain times: several long-term tailwinds (free money, globalization, geopolitical stability, etc.) are now headwinds. No one seems to have an accurate playbook on precisely how these complicated, intertwined “big shifts” will reverberate through the economy and markets. Will inflation remain stubbornly high? Will deglobalization reverse corporate profit expansion? Will government profligacy be curtailed, not by prudence but by bond vigilantes? Will widespread antipathy toward free market capitalism constrain innovation and growth? Are bedrock institutions – e.g. democracy, the judiciary – at risk? So given the difficulty of long-term forecasts, most market strategists revert to questions – e.g. will the Fed will hike 25 bps or not? — that are easier to predict but largely irrelevant over a longer time horizon. Minute shifts in near-term assumptions are extrapolated over the horizon, and the market tail wags the dog. Further, we mostly worry about what we can see, but the real shocks are when new risks suddenly, alarmingly materialize – covid/lockdowns or bank-run-by-smartphone. Through the breathless hysteria of media coverage, it can take time to process both the real scope and magnitude of the issue, but also the policy or private market response.
We believe this uncertainty will benefit hedge funds. The first eighteen months of the inflation trade highlighted the diversification value of strategies that can take, and hold, bold contrarian positions. The extreme valuation disparities of the last decade are likely to revert, and hence benefit investors unbeholden to benchmarks. March did show that it’s not always easy: some of 2022’s hedge fund heroes (i.e. managed futures funds) walked into the SVB propeller. Hence, we opt for diversification across strategies and, synthetically, managers. As more things are likely to break, we continue our attempt to minimize risks – most prominently, counterparty, illiquidity – that are easily ignored during good times but can be damaging in a world of rolling crises.
Performance and Portfolio Positioning
A rally in equities during the quarter was accretive to the performance of the portfolio. However, a pullback in March in small/mid-cap stocks due to the SVB crisis partially offset gains. Short interest rate positions also somewhat detracted but positioning was lessened. Current positioning remains conservative: underweight equities with a bias to cheaper, value-oriented markets. Our sense is that fundamentally-driven hedge funds remain very cautious about the macro environment and believe that higher rates will favor markets – non-US developed, value in small/mid caps, perhaps emerging markets – that underperformed during the 2010s.
Portfolio Characteristics
| Net Asset Class Exposure (%) | |
| US Equities | 18% |
| International Developed Equities | 9% |
| Emerging Market Equities | 10% |
| US Dollar | 3% |
| Fixed Income | -56% |
| Top 5 Holdings | |
| SOFR | -27% |
| 2 Year Treasury | -27% |
| Emerging Markets | 10% |
| EAFE | 9% |
| S&P 400 MidCap | 8% |