Video
iMGP DBi Managed Futures Strategy ETF Update with Andrew Beer | November 2023
In this new video update, Andrew Beer covers topics including October performance, portfolio rotations, macro themes and more! MORE
Interviewee: Andrew Beer, Dynamic Beta investments (DBi)
Interviewer: Mike Pacitto
Date: December 11, 2023
Mike:
Hi everyone, I’m Mike Pacitto with iM Global Partner. Thanks for joining our monthly update on the iM Global Partner DBi Managed Futures ETF Strategy – ticker: DBMF.
As always, I’m joined by Co-Founder of DBi and Co-Portfolio Manager of DBMF, Andrew Beer.
November was an interesting month to say the least, and while we like to keep these video updates short and to the point, there’s a good amount to cover – so I’m going to spare the audience any further prefacing here and get straight to you Andrew for your comments on performance, positioning and markets in general – please begin.
Andrew:
Thanks, Mike.
Boy, this has felt like the Year of the Whipsaw. As our clients know, after a very strong 2022, we had a rough first quarter, then rebounded between 9% and 10% through October, then gave back a bit more than half of those gains in November. We were down around 5%, slightly worse than both the SocGen CTA Index (hereinafter the “Hedge Fund Index”) and the Morningstar US Trend Systematic Category (hereinafter the “Morningstar Category”), and are trailing the overall space this year by 300-400 bps. To be clear, from a replication perspective, we are not concerned about this: variations like this are to be expected, our correlations remain high, and we know from multiple models and sources that we are accurately capturing the core positions across the industry. As a reminder, replication outperformed both hedge funds and mutual funds in 2016, 2017, 2018, 2019, then matched in 2020 only to outperform again in 2021 and 2022. Still, it is of course more frustrating that underperformance this year is happening when the overall space is having a tough year. For professional investors, we’re hosting a zoominar in a few weeks where we’ll dive into more of the nitty gritty on this, so please keep an eye out for an email from Mike – or reach out to iMGP directly.
On the macro front, softer inflation and dovish Fedspeak caused a sharp reversal in rates. Overnight, we went from “higher for longer” or maybe “higher forever” to “taper tomorrow.” The key economic question is whether Powell pulls off this immaculate landing (ie inflation drops nicely with no recession) or whether the economy is hitting the 500-bp-rate-hike windshield. Regardless, expectations that the hiking cycle is over sparked a massive risk on rally with the S&P 500 soaring 9% — recovering all of its losses from the prior three months – and the Bloomberg Agg up four and half percent – and clawing back into positive territory for the year.
So while we often talk about DBMF as a beacon of green in a sea of red – and that was very true in September, October and of course 2022 — last month we were a red blotch in a sea of green. But a sea of green, or a sea of red, should not be comforting to wealth managers: it means that diversification isn’t working the way it used to. The correlation between the S&P 500 and Bloomberg Agg this year is an alarming 85%. If you have a minute, take a look at our website, dbi.co, and a set of slides we wrote called the Great 60/40 Head Fake. The punchline is the 60/40 worked beautifully for a decade but allocators need a different playbook this decade – as we saw clearly last year.
On the macro front, I’d like to take you through two slides that, I think, provide helpful context on the macro world.
With that, next slide please.
This is an amazing chart prepared by Bianco Research. In short, it shows that the market has been wildly and consistently wrong about the direction of interest rates since 2010. That black line is actual short-term rates, and each of those filaments is where the market thought those short term rates would go over the coming year or two. We call this slide “Don’t Believe the Hype” because it shows that “market” quote unquote has no clue. During the 2010s, it was in disbelief that rates could remain that low, so each year it expected rates to rise 100 or even 200 bps in short order. Yet it never happened. Then during covid, the market was utterly certain that rates would not rise for years – one line goes out to 2026. Then when rates started to rise, the market underestimated it each step of the way. So the point is to be very very skeptical when you hear people tell you where rates will be in a year – and if you feel like torturing them, ask them to provide their time stamped predictions over the past decade. Yes, there’s a chance that the next year will be smooth sailing – the Fed tapers, rates drop, both stocks and bonds rise, we’re all happy – but it’s not likely and you might want to plan for stormier seas.
Next slide please.
For anyone with a memory that extends all the back to, say, October, you might remember people saying that the rise in 10 year Treasury yields was “tightening financial conditions” and that the bond market was “doing the job” for the Fed. The argument was that this meant the Fed would not have to keep raising rates. So what’s happened since then? The 10 year Treasury yield plummeted 70 bps and risk assets soared. This chart from Goldman Sachs shows financial conditions easing significantly over the past several weeks – by one estimate, this was the equivalent of 90 bps of cuts. So two conclusions. First, even if you think the taper is a done deal, it could well be priced in. Second, unless the Fed secretly thinks the economy is hitting the windshield, they cannot be happy about this and will likely have to go back to jawboning the market with threats that they’re not done yet. This circular dynamic is why rate volatility has been so frustratingly high.
And speaking of this, let’s take a minute to look at why this rate volatility has been both a good and bad thing for CTAs this year.
Next slide please.
This chart, called Anatomy of a CTA Whipsaw, is a very simple representation of what happened in November. The big driver of CTA returns, as you know, is trend following. This chart shows the yield on the 10 year Treasury this year. Basically, yields were oscillating violently during the first quarter – taper to higher for longer to fears of a global banking crisis. But since then, they marched steadily upward. Trend followers often use multiple window lengths, which provides some diversification. When you have a long and persistent trend, the models line up behind it. So this very simple graphic simple shows how by the end of October, both shorter term and longer term models were betting the yields could keep rising – eg short Treasuries. But now imagine you did the same thing back in May – whereas the longer term models like would still have been short (and hence made money – as we did – on the subsequent rise in rates) shorter models had pivoted out and hence were wrong-footed. More broadly, since the moves in many assets are interconnected, big moves and big reversals like this can play out across multiple positions simultaneously. November was a case study in this. Now, from my perch, as frustrating as these reversals can be, I try to keep perspective that the flip side is that these big waves – like those in 2022 in commodities, rates and currencies — are also the most fertile area for alpha generation over time. So like with periodic drawdowns in equities, we should try to condition ourselves to accept these kinds of reversals as the natural variations inherent in this, and any, investment strategy.
On to the next slide.
To continue my drumbeat, here’s our usual slide on DBMF performance since inception versus stocks and bonds. We’ve generated 900 bps of alpha per annum relative to the S&P 500 – I’m just not aware of a hedge fund ETF that’s ever done anything like that. Just tracking the lines, you can see that we’ve been very negatively correlated to equities for much of the past two years, which helped a great deal during 2022 but has cost us over the past year. Meanwhile, bonds have been dead money for this four and a half year period. So when I think about DBMF, I always try to frame it as a tool – a strategic allocation — in a larger multi-asset portfolio.
Which brings us to the next slide, please.
What if an allocator had decided to go from a 60/40 portfolio to a 50/30/20 portfolio of S&P 500, Bloomberg Agg and the SocGen CTA Hedge Fund Index when we launched in 2019? For compliance reasons, we must show the hedge fund index returns, not DBMF returns, but the general conclusion is similar. Over the past four plus years, returns would have been approximately the same, but month to month volatility would have dropped by over a fifth and the max drawdown was approximately 40% shallower. That would have been a very big improvement. But remember, our allocator is not trying to be a hero – maintaining a high correlation to the 60/40 benchmark is important. And here the portfolio would have achieved these results with a 98% correlation to the benchmark. Which shows why non-correlated assets with high alpha generation are so valuable in diversified portfolios.
And to round out this picture, let’s hop to the next slide.
Here we show the rolling 24 month standard deviation of a 60/40 portfolio. It’s something we cover in those slides on our website that I mentioned. Basically, in the past two years 60/40 portfolios have been hit with a double whammy of higher vols in both stocks and bonds, plus that 85% correlation means they’re not hedging each other – at all. So a typical client might have been thrilled in November, but comparatively miserable in each of preceding three or four months.
To follow the last slide, the potential 20% allocation to the SocGen CTA hedge fund index would have had more stable volatility over the past two plus decades, especially during periods when vol spikes here. In the past few years, it would have capped vol around 10% — not as low as it was five or six years ago, of course, but much lower than it has been. In recent months, the impact would have been very pronounced, reducing rolling volatility by about a third. 60/40 was great during the 2010s, but we think this Brave New World requires a new allocator toolkit that incorporates more diversifiers with low, or even negative, correlations to both stocks and bonds.
Next slide please.
Finally, here’s our standard chart on volatility adjusted positioning. Our positioning hasn’t changed that much over the past month. I think a lot of people expect CTAs to start pivoting out of positions the day they start to reverse. That’s not really how it works. Thinking back to that chart on the 10 year Treasury, even with the sharp drop in rates recently, the trend is still up over longer windows. Big and long moves mean CTAs will hold positions longer during a reversal – and that’s absolutely fine because longer term trends – which DBMF tends to pick up on – are the most important driver of alpha generation in this space.
Yes, managers that also use shorter term models will have pivoted quickly, and those with vol controls will reduce risk faster. This did help them in the latter part of March, but remember that it also cost them when rates resumed the trend upward. As we’ve studied the issue, our general conclusion is that while these things sound great on paper, they often don’t work well in reality. Remember: by the time stop losses or vol controls kick in or shorter models are derisking, most of the whipsaw damage has already been done. We plan to discuss this in more depth in that upcoming zoominar.
So there is no perfect answer, and it can be rational to combine DBMF with single manager funds with some of these features. Today, I do like our positioning because if feels like the market got ahead of itself last month and – again, unless indeed we are hitting the windshield (in which case we have a host of other problems) – we could very well see a reversal, so to speak, of some of the November reversal. And we’re well positioned for that.
With that, I’ll hand the baton back to Mike.
Mike:
Thanks Andrew.
Our closing slide tells the on-going story of how successful this strategy has been very simply, showcasing the since inception performance of DBMF versus the index, which we seek to “plus” replicate by reducing most of the fee drag while eliminating excess complexity via the ETF’s efficient construction. It also contrasts DBMF’s performance against the category average as defined by Morningstar.
Long-term outperformance, which is what we focus on as long-term allocators and investors, against the index has broadened since our last update – beating the SocGen CTA Index by over 200bps annualized since inception. Outperformance against the Morningstar average has also expanded, over 395 bps annualized since inception.
We believe these results are convincing and we hope you do too. The combination of index-plus replication with fee reduction being the purest form of alpha, are the key characteristics of what makes DBMF unique and compelling.
Closing here by saying thanks to all of our clients and to our prospective clients for your confidence and interest in DBMF. If you have more questions about the strategy, would like further information or a call with us please don’t hesitate to reach out – just send us an email at: [email protected]
Until next time – from DBi and from iMGP – thanks for spending time with us.
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