Video iMGP DBi Managed Futures Strategy ETF Update with Andrew Beer | June 2023

Interviewee: Andrew Beer, Dynamic Beta investments (DBi)
Interviewer: Mike Pacitto
Date: June 14, 2023

Mike Pacitto:

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.

We believe with DBMF we have designed the ideal solution for accessing the managed futures category by combining an index-plus replication approach and low fees in an elegant, efficient and effective ETF.

I’m joined as always by Andrew Beer – co-Founder of Dynamic Beta Investments, and co-Portfolio Manager. As usual we’ll be touching on recent performance, macro commentary and current positioning in the strategy … and this month we’ll also be tacking short-term underperformance head on and contrasting that to what we believe is a relatively anomalous period versus the long-term story. 

Let’s get to it Andrew, I hand it off to you.

Andrew Beer:

Thanks, Mike.

We were up in May but still trailed both the SGCTA Index (hereinafter the “Hedge Fund Index”) and Morningstar US Trend Systematic Category (hereinafter the “Morningstar Category”). 

To cut to the chase, we obviously are frustrated with year to date performance relative to hedge funds and mutual funds.  What we’ve seen this year is a 3 sigma event – the replication model is working – in fact our correlations have remained at normal historical levels all year.  However, our particular factor set has underperformed several months in a row.  It’s the statistical equivalent of flipping 5 or 6 tails in a row – unlikely, but it happens.  And it doesn’t meant the coin is broken.  So we expect our performance relative to the Indexes shown to revert to what it’s done in the past – potentially outperform through fee disintermediation with high correlation.  We’ll walk you through this all in a few slides.

On the macro front, make no mistake:  this is a One Trade Market.  Every market is reacting to whether the Fed will keep tightening or not.  One month everyone thinks we’ve hit peak rates, and this reverberates across asset classes; the next month, we’re back to sticky inflation and the ripple effects start all over.  The macro crystal ball is particularly blurry these days, what some hedge funds have called a very “weird” market.  By the end of March, people were calling for a hard recession in a matter of weeks; no more.  The Fed is draining liquidity from some parts of the system while pumping it into others.  Like a drunk stumbling across a highway, we keep watching these macro near misses – regional banks are still standing and still lending, profits haven’t collapsed, employment hasn’t soared and the geopolitical backdrop, while scary, has not deteriorated.  Price moves, not fundamentals, keep driving the market narrative – with breathless stories about unprecedented this and that.  From our perch, it feels like the broad markets will break in one direction at some point soon, which should produce durable trends across the major markets we trade.

Given this market uncertainty, we see a portfolio today with positions that can perform in different markets.  We’re long gold – probably a good place to be if inflation remains high.  Conversely, we’re short oil, perhaps a hedge if that deep recession hits.  We remain short the 2 year Treasury – which looks like the right place today.  Equity positioning keeps moving around – not surprisingly given the market gyrations – and we’re long EAFE and the S&P against emerging markets – but we wouldn’t read too much into it from a fundamental perspective.  Lastly, we once again have a big short the Japanese yen – let’s all hope for a repeat of 2022, when this was our single biggest money maker.

Now let’s move to the next slide:

Here’s our usual slide since inception versus the S&P 500 and Bloomberg Agg titled

“diversification bang-for-the-buck” quote unquote.  Tons of alpha vs both stocks and bonds, even with the limited time from inception since 2019.  Hence this explains our constant refrain about why managed futures should be a strategic allocation in every diversified portfolio – the evidence over decades is compelling.  For our ETF model friends out there, we note that the entire managed futures ETF space is 0.02% of all assets – and we’re half of that — clearly, we’re going to try to change that over the next decade with a lot of education.

Next slide, please.

And … here’s our usual slide with performance since inception against both the SocGen CTA hedge fund index and Morningstar US Systematic Trend Category.  It’s important to frame this frustrating year in a broader context.  DBMF has outperformed both the Index and the Morningstar Category since inception with a correlation of around 90%, in an ETF with an expense ratio of 0.85%.  For professional investors, we encourage you to evaluate related performance back to 2016, if you have not done so already.

One important stat is that DBMF has outperformed the Morningstar Category space by 340 basis points since inception.  Another important stat which isn’t on this page is that while you, as an allocator, are looking at the mutual funds and ETFs today, you are staring at a highly curated group of guys who, on average, have done a lot better than the index.  How could this be?  Because firms aggressively shoot the wounded and hide the bodies.  When we launched the strategy underlying DBMF in 2016, there were 49 mutual funds and ETFs in the Morningstar Category .  30 of them have been closed – many run by top tier firms.  Those funds that have done better recently get marketing dollars and show up in your inbox.  So the challenge is how to see through the fog of hot dot sales.  Feel free to reach out if you want get data or discuss further.

Next slide, please.

Now let’s get to the meat of what we want to discuss today.  Despite underperformance this year, the replication model is working as expected.  The chart on the left plots monthly returns over the past twelve months against the hedge fund index.  Clearly, we are pointing in the same direction:  when they go up, we go up; when they go down, we go down.  For the statistically inclined, our correlation is 0.8887.  Now look at the two colors of those dots:  the 2022 dots tend to be above the trend line, while the 2023 dots are consistently below it.  We expect monthly variations – replication is an estimation, a synthesis, and so we do expect month to month noise.  Over time, the noise tends to be random – we outperform one month, give back a little the next, etc. – and it smooths out over time.  When you cut out fees and expenses, you get what’s called upward drift quote unquote – and a year later, we tend to outperform the vast majority of the time.  Every now and then, just like flipping coins, you can get a either several heads – which is great —  or tails in a row – which is frustrating.  That’s what’s happened this year – several tails in a row.

How unusual is that?  Very.  The chart on the right shows the rolling six month performance of DBMF since inception in 2019 vs the hedge fund index.  The current six month underperformance is the worst we’ve seen – a three sigma event which equates to around a one in one hundred chance of happening.  So this can happen, but it’s very rare.  Note that there also are plenty of examples when we keep flipping heads and the noise plays in our favor.  If you look at longer periods, with both related and hypo numbers, this period is definitely unusual but certainly not unprecedented.  By the way, if you are statistically nerdy, you will note that the distribution is leptokurtotic, which is a very, very cool way of saying that tend to outperform more than you underperform.

Hence, we conclude that underperformance might be temporary and DBMF has the potential get back to the pattern of outperformance through fee disintermediation that is the cornerstone of our approach.

Next slide, please.

To go one step deeper, here’s a little research project that blows up some myths about diversification and CTAs.  Ask yourself:  what is the one trade that is driving dozens of markets this year?  The Fed and inflation.  And the instrument most sensitive to it is the 2 year Treasury.  That chart on the right shows a replication model using only the 2 year Treasury – literally, only a single factor.  So every Monday, you run a regression that says “to mimic the recent performance of a diversified basket of large CTAs, each of whom trades dozens and dozens of futures contracts, you’d want to be x% short the two year Treasury.”  Then you short the Treasury future in the same weight and go home till next week.  Magically, you would have matched the performance of the Hedge Fund index with a correlation well above 90%. 

Now look at the line that underperforms:  when you add exposure to currencies, equities and commodities – ordinarily, helpful sources of diversification — performance gets worse.  Your correlation does remain high – not as high, but high — but you can see this grinding underperformance – the succession of tails – that we see in DBMF.

Now turn to the chart on the left.  Over a longer period of time, trying to replicate the Hedge Fund index with a single factor is a terrible idea.  We know that, and everyone in the space agrees with us.  A four factor model, by contrast – just the 2 year Treasury, S&P 500, crude oil and dollar index – not only can replicate the index with high correlation, but also can materially outperform through fee and expense diversification.  This was the “a ha” moment we had back in 2015.  We eventually expanded our factor set to ten to pick up more major markets, but this notion that you need seventy instruments to achieve diversification is generally a fallacy.

So what’s going on?  On the research side, we also run our own simple trend following models to see what positioning looks like – a good reality check on our factor models.  What we see is really interesting:  some of the most valuable positions this year actually are highly correlated to the 2 year Treasury.  Rather than offer diversification, the positions result in a doubling up of risk in the 2 year – and hence look more like the unconstrained two year model we just discussed.  To be fair, some other futures outside our factor set, such as certain minor market commodities, also have contributed to performance.  But the biggie is the 2 year, the one trade market.  On our end, the combination of a focus on major markets, plus some constraints in the regulatory limits on what 40 Act funds can invest in , (ie limits on illiquid securities and commodities), means we’ve been pointing in the same direction, but not picking up the same magnitude of performance. 

So, back to where we started:  this is all incredibly unusual, we understand what is going on and are not worried, and we think we’ll soon look back on this period as highly, highly atypical.

Next slide, please.

Here’s our standard chart on volatility adjusted positioning.  The big shifts over the past month are a move to a significant short position in crude oil, a build up in the short position in the Japanese yen, a compression of a spread trade between EAFE and the S&P 500 (which more recently went positive), plus an increase in the short position in emerging markets equities.  We remain long gold and short the front and back of the Treasury curve, but have flipped to a modest long in the ten year.  Taken together, this looks to us like a portfolio that might benefit from a recession or stagflation.

With that, I’ll hand the baton back to Mike.

Mike Pacitto:

Thanks Andrew.

I opened by describing DBMF as elegant, efficient and effective – this slide tells the story very simply, showcasing the since inception performance of DBMF versus the category average as defined by Morningstar – and while it’s not all about fees, I think Jack Bogle proved convincingly that they certainly matter. In fact, they matter a lot – especially in the managed futures category. This simple notion is one of the mottos of Dynamic Beta – that fee reduction is the purest form of alpha – and it’s a key characteristic of what makes DBMF unique and compelling.  

So I’ll close here with this 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: team@imgpfunds.com 

Until next time – from DBi and from iMGP – thanks for spending time with us.

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