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

Interviewee: Andrew Beer, Dynamic Beta investments (DBi)
Interviewer: Mike Pacitto
Date: September 7, 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.

This month’s video update is going to be a good one, as we’ll be hearing as always from Andrew Beer, co-founder of DBi and co-portfolio manager of DBMF. He’ll be touching on some macro items, the competitive landscape, performance, positioning, etcetera – but the emphasis will be mostly on two specific topics that are both compelling and ground-breaking, respectively.

I don’t want to give any spoilers here, but Andrew will be touching on some very interesting findings around these two topics alongside our standard update – and so with that let’s get to it, I hand it off to you Mr. Beer.

Andrew Beer:

Thanks, Mike.

We were up around 0.3% in August on price basis with both equities and bonds down a decent amount.  As importantly, we were about 70 bps ahead of the SocGen CTA Index (hereinafter the “Hedge Fund Index”), which as you all know is an index of twenty leading managed futures hedge funds.  During the third quarter so far, DBMF is outperforming the index by around 150 bps – making back some of the ground we gave up early this year after we outperformed by around 300 bps net last year. 

On the mutual fund and ETF side, the Morningstar US Trend Systematic Category (hereinafter the “Morningstar Category”) lost about 80 bps last month, a bit worse than the hedge funds.  Note that the Morningstar Category also underperformed those hedge funds by around 600 bps last year, which explains why we decided to try to replicate what the real hedge funds are doing. 

On the macro front, it’s safe to say that Confusion Reigns Supreme.  The economy just isn’t supposed to be this resilient in the face of 500 bps of Fed rate hikes.  Maybe it’s because there’s pent up savings, or your brilliant neighbor locked in a thirty year mortgage at 3% and is perfectly happy to stay put, or the government keeps spending like there’s no tomorrow.  That’s the Teflon economy.  Or, maybe the shockwave is coming but it hasn’t hit – a Delayed Boom — and when it does it will be a doozy:  zombie companies finally get shot, commercial real estate goes poof, consumption plummets.  Or maybe we skate through in some modern day Goldilocks scenario – the theme du jour.  Taken together, we have three very different paths in front of us:  higher for longer, a quick taper and a return to the Go Go 2010s, or something much worse where inflation reaccelerates like in the 1970s.  As consensus keeps flipping back and forth, markets keep oscillating, and it has definitely not been a wonderful environment for trend followers.  Not disastrous, but more like two steps forward and two steps back. Of course, after 2022, we think these guys deserve a bit of rope.

By the way, on the macro front, we do have two slides that I’ll show in a sec that, we think, are worth – maybe — printing and putting up on a wall somewhere. 

But before we leave this slide, let’s talk about our positioning.  We are long the Euro and short the Yen, which you can think of as a bet that the EU will keep raising rates but, damn it all, Japan will not.  This has been our one profitable asset class this year, in large part because the Yen is down something like 13%.  Recall also, that the Yen was our most profitable position last year.  While other markets keep oscillating, the intransigence of the Japanese monetary authorities has been a gift to trend followers.  A funny historical note:  trend following in currencies was essentially dead money for years, and in 2020 an allocator asked us to build a trend follower with no exposure to the space; we refused under the theory that dormant markets can suddenly become very “trend-y.”  So we would caution everyone against trying to predict which markets – from a trend perspective — will be most valuable over the coming few years – it really seems that diversification across all asset classes just appears to work better over time.  Moving on, we are short Treasuries, so we’re well positioned if inflation rises again from here – that’s the topic of one of the upcoming charts.  We are also modestly long equities, short gold, and long crude oil.  Overall, I’d say that, in the short term, we’re positioned for “higher for longer” on the inflation front.  Of course, please remember that the portfolio is dynamic, so you should read these positions as reflecting current market sentiment, not a long term forecast.

So, to keep this moving, let’s jump to the next slide:

We have two special slides this month.  This one shows the long term correlation between the S&P 500 and Treasury yields, courtesy of Refinitiv.  When it’s above zero, bonds are a good hedge against equities.  When it’s below, they’re moving up and down together.  Most of you grew up in a world where the hedge was working – but now welcome to a Generational Shift, as coined recently by the Wall Street Journal:  the hedge ain’t working anymore.  This is DefCon 5 for $5 trillion of model portfolios – the cornerstone of which is how combining the two major asset classes can give clients a smoother ride.  If that line stays below zero, a 60/40 portfolio will be a scary rollercoaster over the coming decade – and clients do not like when you put them on scary rollercoasters.  Further, most diversifiers, which are linked to either stocks or bonds, won’t help much.  Hence, we think every allocator out there should drop everything else and look for diversifiers that have no correlation to either stocks or bonds – and if you’ve already bought into a strategy like managed futures, then you might want to materially increase your allocation.  The asset allocators of 2030, armed with data from the 2020s and trying to build nice optimized models, are likely to want a 10% or higher allocation to managed futures, and we suggest you get in front of that wave.

Next slide please.

This chart compares the path of inflation in the 1970s to today.  The blue line is the nightmare of the 1970s – the Fed thought that it had squashed inflation, relaxed its grip and then it came roaring back – helped, of course, by OPEC.  The orange line is today.  Battle hardened economists like to point to this chart to make two arguments.  First, don’t be complacent that inflation is dead yet.  Second, no one at the Fed wants to be the guy who made that mistake in the 1970s, so don’t expect the Fed to start cutting until it’s crystal clear that the beast is tamed.  The smart money these days seems to think rates will remain high, which happens to be when stock and bond correlations tend to be positive – like the past eighteen months, like August, and that this will ripple through markets for years.  Maybe not a single, violent shockwave, but rather a series of “rolling crises” like SVB in March. 

Next slide, please.

So that was my great windup as to why managed futures should be a strategic allocation in your portfolios alongside stocks and bonds over the coming decade.  Eric McArdle of Simplify – our competitor but kindred spirit in our belief that managed futures should be an essential part of every diversified portfolio — coined a very good metaphor:  that managed futures anchors the third leg of the asset allocation stool.  Most diversifiers are simply shoring up one leg or the other, which isn’t likely to stabilize much going forward.

Hence, with managed futures you have one of the few low or zero correlation hedge fund strategies that you actually can deliver in a mutual fund or ETF.  : Hell, the largest competing brand name hedge fund strategies are alpha generation machines with zero correlation to anything — but you pay 10% a year in fees, have to tie up your money for a decade, and need to be able to write a $100 million check to get them to answer the phone.

So with that preamble, here’s our performance since inception versus the S&P 500 and Bloomberg Agg.  Since launch in 2019, we’ve delivered between 9% and 10% per annum of alpha relative to the S&P 500.  And DBMF has returned 45% cumulatively when bonds have lost money.  It really shouldn’t be a question of whether a strategy like this goes into a diversified portfolio, but rather how much.

Next slide, please.

As the guys who replicate hedge funds, of course we need to talk about how we’re doing relative to them.  Here’s our chart with performance versus the Hedge Fund Index and Morningstar Category.  The punch line is that DBMF has outperformed both since inception with a correlation of around 0.9.  As I think everyone listening to this will know by now, we are simply trying to deliver as much of the pre-fee performance of the space as possible, but with lower fees and very low trading costs.  Hence, we think replication potentially is a way to consistently outperform both hedge funds and mutual funds – not through more clever modeling or esoteric instruments, but by identifying the core exposures of leading hedge funds and mimicking them with deep, liquid futures contracts.

If you haven’t seen it, you might want to google a paper we just published in Institutional Investor.  The title is, “Is Managed Futures the Perfect Asset Class for Replication Strategies?”  We show data – and the next slide is eye opening – but also provide a framework.  In essence, managed futures hedge funds and mutual funds build “wave detectors.”  They point them at the market sea – zooming in on seventy or more individual futures contracts.  At any point in time, some will be going up, some will be going down, and some won’t be doing much.  The fairly obvious point, though, is that waves move in clusters.  Many instruments are inextricably linked to others:  does anyone seriously think the 10 year and 30 year Treasury contracts will move in completely different directions over the next ten years?  Of course not.  Or that natural gas would decline during a commodity supercycle?  Come on.  And futures only move up and down.  So what replication really does is to try to identify the clusters as determined by the wave detectors – then simply invest in the deepest and most liquid futures contracts within that cluster.  And it turns out that the “clusters” drive alpha generation, not some 2% position in some esoteric, thinly traded contract.  This has two great potential benefits:  it’s much more efficient than buying and selling individual waves, and there is no risk of market crowding, which means we are happy for you to see our positions every day in a transparent ETF.

Next slide, please.

The only people who really question whether replication can and should work are people who build and run highly profitable wave detectors.  This is understandable:  a few decades ago, this was an esoteric and exclusive strategy where they could charge people 10 points a year for the privilege of investing; today hedge funds might make 3 percent and the average mutual fund is down 1.7% according to data from Bloomberg and Morningstar, respectively. Not low, but lower. All this is because the space has been on a long and winding path to commoditization:  thirty years ago, only a handful of people knew how to build these things – the data was hard to get, derivatives like futures were arcane, you had to know how to program.  Fast forward to today, and some retail investors post their own models on twitter, er, X.  Commoditization is not great for managers but a terrific thing for allocators.  Replication is another brick on that road, and so sometimes practitioners feel the need to toss a grenade or two in our direction.

The most common grenade, or criticism of replication, is that the portfolio is too simple.  In DBMF, we use only ten core factors to replicate portfolios which might have, on average, seventy futures contracts.  That gets us to a correlation of around 0.9 over time.  To end this discussion once and for all, we decided to show what a replication of the SocGen CTA Hedge Fund index would look like using only four futures contracts:  the 10 year Treasury, crude oil, Euro and S&P 500.  One big contract per asset class.  We aim the replicator at the estimated pre-fee returns of the space, by simplistically adding back a 1% management fee and 20% performance fee.  So in the chart, the bottom line is the performance of the index, the orange line above it is estimated pre fee returns, and the black line on top is the replication.  Over fifteen years, the blindingly simple replication model would have essentially matched the pre-fee performance of the twenty leading managed futures hedge funds in the index with a correlation of around 0.8 and shallower drawdowns – all with the same diversification benefits to both stocks and bonds.  Mind you, the drawdown of this simple four model would have been much shallower than that of the index – which completely destroys the argument that fewer positions is somehow riskier. 

To follow the metaphor, as a general rule we think an allocator should want the clusters cheaply, not the individual waves expensively.  We encourage you to look up the article if you want to read a bit more about the analysis and conclusions.  And by the way, if you ever want to see what a replication of a single manager mutual fund or ETF looks like, call us.  It’s quite illuminating.

Next slide please.

Finally, here’s our standard chart on volatility adjusted positioning.  As a reminder, we show volatility adjusted positioning since it can be confusing when looking a notional position sizes – what looks like a big position in something like the two year Treasury might be less risky than a small position in crude oil, so this helps to make the exposures more apples to apples.  This month we’re also showing it relative to June 30 to underscore how dynamic the portfolio has been over the summer. 

To start from the left, we flipped from short to long crude oil, and from long to short gold.  We’ve increased our long position in the Euro, but cut back a bit of the short in the yen.  We’re short across the Treasury curve, whereas after the SVB unwinds we had flipped for a period to long the 10 year.  And lastly, we’re modestly long equities and have unwound an spread trade that the S&P 500 would outperform non-US developed stocks and EM.

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

Mike Pacitto:

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: team@imgpfunds.com 

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

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