Author: Karrie Gordon

March has been a rollercoaster month for markets. The collapse of two regional banks mid-month sent shockwaves throughout the bond market that reverberated globally as investors fled to Treasuries, driving yields down sharply. It was a drastic change that caught most managed futures strategies suddenly on the wrong side of the Treasuries trade. I recently had the chance to talk with Andrew Beer, co-portfolio manager of iMGP DBi Managed Futures Strategy ETF (DBMF) and managing member of Dynamic Beta investments, about what the sudden changes mean for managed futures and one of 2022’s top-performing ETFs.

Inflection Point Vs. Regime Shift

Tension remains high in the banking sector as banks rush to keep First Republic afloat in the U.S. and prevent possible contagion in the wake of the Fed takeover of two regional banks, Silicon Valley Bank and Signature Bank, while overseas the Swiss National Bank stepped into backstop Credit Suisse as it waits for a takeover by UBS.

The rapid collapse of SVB in the U.S. followed within days by Signature, caused investors to flood into Treasuries, driving yields down in the sharpest decline since the Financial Crisis. March 8 was an inflection point for bonds and the sudden drop in yields created a significant pain point for CTA strategies that benefited from a short position on Treasuries for the last year.

The yield on the two-year Treasury dropped from 5.05% on March 8 to close two days later at 4.6% while the 10-year dropped from 3.98% to 3.7% over the same period, the sharpest two-day decline since the Financial Crisis.

“CTAs hate inflection points but love regime shifts,” explained Beer. “Mid-March was an inflection point:  does this reflect a new regime and, if so, shouldn’t there be great money-making opportunities like during the GFC?”

Only time will tell what effect bank sector turmoil will have on markets and consumers as banks tighten and reduce lending, leading to less liquidity for consumers and businesses still toiling away in an environment of high inflation and reduced purchasing power. A recent Bank of America survey of global fund managers revealed systemic credit risk as the top tail risk for 2023 and fund managers are buckling up for the ride, with 41% of participants reporting lower-than-average risk-taking.

“CTAs historically have performed better in months 2-6 of a crisis. This could be week three of a global banking catastrophe,” Beer hypothesized.

The Short- and Long-Term Outlook for Managed Futures

CTA managers may have been caught by the abrupt drop in Treasuries mid-month but it’s important to remember that while inflection points hurt in the immediate days and weeks after. It’s pain that tends to be more temporary for strategies that can rapidly adapt to changing trends. If this is the beginning of a regime shift for markets, CTA strategies will be flipping positions to capture the shifting tides.

“This week and next, CTAs will jettison losing positions and hunt for new trades better suited for this new regime,” Beer explained. DBMF, which employs a replication strategy of the average performance of the largest CTA hedge funds, has already picked up a long position in the one-year Treasury after being short Treasuries for months.

As to the outlook in the interim, Beer is keeping an eye on liquidity. A banking crisis would elevate the importance of liquidity and few strategies available to investors can offer liquidity like managed futures. Furthermore, Beer argues that a banking crisis that leads to both Treasuries and stocks faltering would propel investors into the futures market, providing further liquidity in the event of extreme market stress, dislocation, or breakage.

“Now we see where the real leverage is in the system: not futures, which are liquid, but rather illiquid assets financed by lenders. That’s where the real action will be.”

Looking further ahead, continued banking turmoil and crisis would create an entirely different environment from last year, which Beer described as an “orderly repricing of assets”. In the event of bank contagion or continued stress, volatility amongst any number of asset classes could be pronounced and unpredictable.

Managed futures remain a compelling addition to portfolios for their non-correlated return stream and the strong uncertainty of the outlook for even the next month, much less six months from now. Even Fed officials remain uncertain as to the path of monetary policy, given the addition of bank stress as a major factor. Predictions for interest rates next year range anywhere from 3.25%-5.75% according to the FOMC dot plot released post-March meeting.

Image source: Federal Reserve

For now, the only certainty seems to be uncertainty as markets continue to unwind from a decade of underlying Fed puts that suppressed market volatility and led to a boom in equity and growth strategies that have since faltered and fallen. It’s the kind of environment that managed futures can thrive in as regimes shift, providing strong diversification for portfolios.

“As we have been saying for a year, the implosion of the Superbubble likely will play out over years, not quarters,” said Beer. “This should present plenty of compelling opportunities for CTAs.”

Investing in Managed Futures With DBMF

The iMGP DBi Managed Futures Strategy ETF (DBMF) allows for the diversification of portfolios across asset classes uncorrelated to traditional equities or bonds. It is an actively managed fund that uses long and short positions within the futures market on several asset classes: domestic equities, fixed income, currencies, and commodities (via its Cayman Islands subsidiary). DBMF is currently down 10.86% YTD as of 03/23/2023, presenting a buying opportunity for advisors and investors seeking long-term diversification for their portfolios.

The fund’s position within domestically managed futures and forward contracts is determined by the Dynamic Beta Engine, which analyzes the trailing 60-day performance of CTA hedge funds and then determines a portfolio of liquid contracts that would mimic the hedge funds’ averaged performance (not the positions).

DBMF takes long positions in derivatives with exposures to asset classes, sectors, or markets that are anticipated to grow in value and takes short positions in derivatives with exposures expected to fall in value.

DBMF has management fees of 0.85%.

For more news, information, and analysis, visit the Managed Futures Channel.

Global asset managers and banks have consistently issued caution in their 2023 outlooks as they anticipate developed market central bank policies to exacerbate many of the challenges of 2022. While individual analysis of asset classes and countries varies, the consistent messaging is that volatility is likely here to stay.

“There is good and bad news for equity markets and more broadly risky asset classes in 2023. The good news is that central banks will likely be forced to pivot and signal cutting interest rates sometime next year, which should result in a sustained recovery of asset prices and subsequently the economy by the end of 2023,” said Marko Kolanovic, chief global markets strategist and co-head of global research at JPMorgan in a 2023 market outlook. “The bad news is that in order for that pivot to happen, we will need to see a combination of more economic weakness, an increase in unemployment, market volatility, decline in levels of risky assets and a fall in inflation.”

This volatility isn’t just forecast for the near term, however, but is part of a larger continuing regime shift.

“The Great Moderation, the four-decade period of largely stable activity and inflation, is behind us. The new regime of greater economic and market volatility is playing out – and not going away, in our view,” wrote BlackRock in its 2023 outlook.

Goldman Sachs takes a somewhat optimistic but cautioned outlook for the year based on two scenario possibilities: either the U.S. narrowly avoids recession and risk assets benefit, or the U.S. enters a mild recession followed by a strong stock rally similar to what has been seen in previous economic downturns.

“Our base case implies financial markets can regain traction in 2023. In equities, we see more paths to gains than losses by year-end. Bonds are also expected to rise, as today’s higher yields provide an ample cushion to absorb any further increase in interest rates. But there will no doubt be curves along the road ahead,” Goldman Sachs wrote in its 2023 outlook.

Even in this more hopeful outlook for U.S. equities by year’s end, there is a high degree of implied volatility and a massive shift in market trends in the second half of the year. All of these are things that managed futures strategies capitalize on, making them a worthwhile consideration within portfolios in both the near term and the longer term.

Investing for Volatility With DBMF

Managed futures strategies largely offered strong performance last year, capitalizing on market volatility and dislocations. The iMGP DBi Managed Futures Strategy ETF (DBMF) has been an immensely popular choice for advisors and investors alike in the last year. With the economic downturn and challenges ahead this year, DBMF could be positioned for continued outperformance; at a minimum, it offers strong hedging potential for equity underperformance in the near term.

DBMF allows for the diversification of portfolios across asset classes uncorrelated to traditional equities or bonds. It is an actively managed fund that uses long and short positions within the futures market on several asset classes: domestic equities, fixed income, currencies, and commodities (via its Cayman Islands subsidiary).

The fund’s position within domestically managed futures and forward contracts is determined by the Dynamic Beta Engine, which analyzes the trailing 60-day performance of CTA hedge funds and then determines a portfolio of liquid contracts that would mimic the hedge funds’ averaged performance (not the positions).

DBMF takes long positions in derivatives with exposures to asset classes, sectors, or markets that are anticipated to grow in value and takes short positions in derivatives with exposures expected to fall in value.

DBMF has management fees of 0.85%.

For more news, information, and analysis, visit the Managed Futures Channel.