Interviewee: Andrew Beer, Dynamic Beta investments (DBi)
Interviewer: Mike Pacitto
Date: March 8, 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.
We believe DBMF is a true game-changer in the managed futures space – and for asset allocation in general – by combining an index-plus replication approach with low fees in an elegant, efficient ETF. Along those lines, we think you’ll find that DBMF is a powerful diversifier that adds multiple layers of value to portfolios.
I’m joined as always by Andrew Beer – co-Founder of Dynamic Beta Investments and co-Portfolio Manager of DBMF. He’ll be touching on February performance, current positioning, a bit of macro commentary and some dispelling of myths around the risks of managed futures that I think you’ll find quite surprising in a good way.
Let’s get to it Andrew, I hand it off to you.
Andrew:
Hi Mike and greetings everyone.
Let’s start with the macro backdrop. This tug of war in the markets continued as “too hot” inflation figures upended the Goldilocks thesis. As you’ll recall from last month, the Goldilocks thesis is that the economy will slow, inflation will drift back down to 2%, rate hikes will peak soon and the Fed will start cutting again in the second half of this year – all without a major recession. Last month, we had some inflation data come through that makes it look like, to put it simply, people just don’t want to stop spending money. Lord knows governments don’t want to either. So the Fed kept reminding people that it’s job is not done, rates then spiked, equities dropped and expectations of where short term rates will peak spiked well above 5%. And that’s the tricky paradox of the market right now: the better things look, the more ebullient the markets, the more likely the Fed needs to keep hiking, the worse it is for markets. It all feels like a game of chicken. The Cassandra camp – all these grizzled macro traders who remember the 1970s – think it’s going to take years to work through the excesses of the 2010s and that investors should be prepared for a very tough market environment and, essentially, not keep calling the Fed’s bluff. We tend to lean more into the Cassandra camp – essentially because spending is addictive, and anecdotally, it just doesn’t like the economy is slowing enough to bring it down fast.
But we’re not in the macro prediction business: we are in the hedge fund replication business. So let’s talk about performance. We made a little back in February but are still down a few percent for the year. The broader managed futures space is doing a bit better – slightly up – with a very wide spread between winners and losers. These kinds of variations are natural for our strategy – replication works incredibly well, but not perfectly. You may have seen some of our charts on rolling one year performance, where the strategy has outperformed the index over 90% of the time but with plenty of quarters where we fall behind then catch up later. If you were invested with us last year, you would have noticed similar variations – and then we ended up about 350 basis points ahead of the index at the end of the day. The key is that the model continues to work as expected and our goal remains to outperform consistently through fee disintermediation. The math of compounding those fee savings is that DBMF has outperformed the index of leading hedge funds by about a third since launch in 2019.
On contribution and positioning, we’re glad we maintained the short positions in Treasuries as those made money last month. As this equity market has grown roots, we’ve pivoted to a long position in non-US developed markets, which offset some of the gains on rates. Consequently, the portfolio is more balanced than it was last Fall when we were all in on various legs of the inflation trade. As this is what I’d expect to see: we have these two widely divergent views in the markets, and the funds are finding ways to express both sides, hopefully in a way that generates stable, incremental returns through the market gyrations.
Next slide, please.
Here’s the updated slide on performance since inception. Since launch in 2019, we’re up around 49% on a cumulative basis, a tiny bit more than the S&P and a world of difference from bonds, which are modestly down. Our correlation to both stocks and bonds is negative – moreso to bonds than stocks. That’s a function of having just gone through 2022, where when we went up, they went down. In five years, I’d expect the long term correlation stats to be closer to zero.
When you eyeball the chart, you can see the bit pivot in late 2021 when every time the market drops, we seem to spike – and then later in the year, the opposite. Clearly, this is when the inflation trade kicked into gear. One way to look at this is as follows: if you look at the long term data on the space, you can classify about 20% of the time as “crisis periods.” During those periods, the strategy outperforms equities by 50-70% — just like we saw in January through October of last year. During the other 80% of the time, hedge funds historically have delivered cash plus 1%, net of all the fees and expenses we’ve talked about. So we get asked this question a lot: what if the crisis really is behind us and we have more normal market conditions over the next five years. Given that our cash is yielding more than 4% today, and our ability to cut out fees and expenses, I’d hope that we can deliver high single digit returns just by capitalizing on the normal gyrations in the markets – in a sense, riding waves that might not be tsunamis like last year, but should hopefully be large enough to create opportunities to make money.
Next slide please.
Here’s a slide called Goldilocks vs Cassandra. I clearly like these slides that show how the market consensus – and markets themselves – flip back and forth. The black columns are January and the orange columns are February. Two observations: first, fixed income reversed January gains “harder” and are flattish this year; equities gave back some gains but are still having a very strong year. This sort of explains that spilt positioning that I just described: the funds are saying that equities can keep rising if rate hikes continue – especially cheaper value stocks like those in non-US developed markets – because maybe a strong economy means they avoid a big earnings recession. But they’re also saying that bonds have nowhere to hide with more nasty surprises on the inflation front. The second observation – and this is not a wildly scientific or statistical conclusion – is that almost everything is going up and down together. This is really, really bad for 60/40-land. And really, really good for our argument that managed futures should be a strategic allocation across wealth management portfolios because it is one of the few strategies that has no correlation to both stocks and bonds. Almost every other diversifier goes up and down with either stocks or bonds, and if those are rising a falling together, then so too are your diversifiers. Hence, you’ll be hearing this guy maintain the drumbeat of “stocks, bonds and managed futures” whenever he can find a bullhorn and pulpit.
Next slide please.
Here’s our volatility adjusted positioning. As noted, the rotations continue. The big one is the pivot to net long equities: today, a sizeable long position in non-US developed stocks with hedges in the S&P 500 and emerging markets. On the surface, that might seem incongruous with rates popping higher. But if we are in a world with structurally higher rates, then value stocks should do much better – and stocks are much, much cheaper outside the US. Recall that during the 2010s, it really was all about US equities – the S&P 500 rose four times as much as non-US counterparts, in part because of the tech bias here and how important low rates were to support those valuations. So the long EAFE-short S&P positioning potentially reflects a shift in sentiment – a decade where the other guys play catch up. Incidentally, I was just reading capital markets assumptions from a number of big banks, and literally everybody has a forecast that this is the decade where non-US fights back. Obviously, managed futures funds are not making grand prognostications about the next ten years, but I always find it interesting when I see these tactical trades line up with bigger, strategic shifts in thinking. Sometimes, like the early days of the inflation trade, managed futures might pick up on market breadcrumbs – essentially, seeing that some investors were shifting their positions to prepare for a regime shift. It will be fascinating to see how this plays out over the coming months.
Next slide, please.
This is my favorite talking point these days, and I just gave a speech on this in London. Managed futures is perceived – I believe wrongly – as a highly risky strategy. When people hear “futures” they imagine blow ups and it’s just not reality here. This chart shows the drawdowns of the SocGen CTA index, S&P 500 and Bloomberg Agg since 2000. The S&P has suffered two drawdowns of more than 40%; the Agg was steady as a rock until the bond superbubble burst last year, dropped 17% and gave back half a decade of returns. Managed futures goes through periodic drawdowns in the 10% range, but never has had a drawdown of more than 14%. That’s quite incredible: a drawdown less than a third of equities (twice!), and now less than bonds.
What I tell people is that this is very much by design. Managed futures models almost always are configured to cut losses. I joke that no one programs a model with a “white knuckle grip.” And here is where I think about futures in a very different way: if you want to be able to exit a position quickly, futures contracts are highly liquid. When the world goes to hell, people rush to futures markets to hedge, so even in a month like March 2020, when you literally could not trade some stocks and bonds, there was more liquidity in our futures contracts than in February or April.
So here’s how I think you should view this in the context of the past twenty three years: the space will go through periodic 10% drawdowns, then it will recover. That’s roughly what happened starting in November and, as we’d hope, the funds cut risk, dump positions that have reversed, and hunt for new trades. For long term investors, I think this modest volatility is a small price to pay for those diversification benefits. I’ll now hand the baton back to Mike.
Mike:
Thanks Andrew.
I opened by describing DBMF as a game-changer in the managed futures space – and when you compare it to the category at large and the most commonly utilized index using the simple measurements of expenses and performance, these bar charts speak for themselves.
By combining low fees with mitigation of single-manager risk through DBi’s index-plus replication process, we hope you’ll agree that this efficient, elegant approach is a very compelling way to access managed futures and implement them into portfolios with great efficiency.
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.