DBMF ETF: A Trend Following Hedge Fund In An ETF Format (NYSEARCA:DBMF)

Thesis

The iMGP DBi Managed Futures Strategy ETF (NYSEARCA:DBMF) is an exchange traded fund, but its strategy is a very complex one. The first rule of investing is that one must understand what they buy. As per its own literature, DBMF:

seeks to replicate the pre-fee performance of leading managed futures hedge funds and outperform through fee/expense disintermediation.

In this article we are going to aim to translate into laymen’s terms what the fund actually does, and present our view on why a retail investor can use this name as a portfolio diversifier.

What is a hedge fund strategy? When risk factors are opaque.

Let us start with the definition of hedge funds:

A hedge fund is a pooled investment fund that holds liquid assets and that makes use of complex trading and risk management techniques to improve investment performance and insulate returns from market risk. Among these portfolio techniques are short selling and the use of leverage and derivative instruments.

Investors are very familiar with instruments which are either long or short a section of the market, be it equities or fixed income. When you buy the SPY, you are basically buying into a long equity exposure. Similarly, when you are buying into the iShares 20+ Year Treasury Bond ETF (TLT), as an investor, you are buying long duration treasury bonds. Your risk factors are very clear and transparent.

Hedge funds, on the other hand, can take long or short positions that can change over time, and to add to the complexity, DBMF takes positions across asset classes. At the end of the day, the manager has the mandate to change its positioning constantly; hence you do not know what the risk factor is. Risk factors change constantly, and the only item to consider here is the portfolio manager’s acumen and long-term performance.

This is the most important aspect to remember about DBMF, because as per the fund’s own disclosures:

The fund will employ long and short positions in derivatives, primarily futures contracts and forward contracts, across the broad asset classes of equities, fixed income, currencies and commodities.

The fund can therefore be long or short equities, fixed income, currencies and commodities at any point in time. There is a nifty piece from the fund manager that talks in laymen terms about this strategy:

First, what is “managed futures”? There are three things to know. It’s a nimble hedge fund strategy that’s been around for over fifty years.

Managers build computer models to detect “waves” in the markets – for instance, is crude oil going to keep going up? Or are equities going to keep going down?

DBMF use their own quantitative tools and models to figure out what leading hedge funds are doing, then utilizes that positioning data to overlay it into the fund.

Current portfolio positioning

As we have established above, the fund’s portfolio positioning is going to change constantly, but we can nonetheless have a look at how the vehicle is currently set-up:

The current portfolio contains a large amount of cash parked in Treasury Bills (line 1 of the excel), due to the low margin requirements when futures are used.

The ETF is currently long WTI Futures, Equities via the MSCI EAFE futures and S&P 500 futures, short the Euro and Yen and the 10-year and 2-year Treasury notes.

The fund’s positioning is interesting, but consistent with trends observed in the market and even with some of our own research. In our coverage of commodities related funds (PDBC: Time To Buy This Unloved Commodities Fund) we highlighted our bullish view on gold and oil. DBMF’s positioning is consistent with that view.

It is very interesting to note the fund’s take on the fixed income markets – the manager is short the intermediate portion of the curve (2 year and 10 year) but bullish the long end of the curve. There is indeed increased talk in the market of a re-visit of 5% rates for the intermediate portion of the yield curve, as rate cut expectations are pushed out.

As mentioned in the prior section, the positioning can change constantly, so the manager has the latitude to alter the current set-up on any given day. Today’s risk factors will not necessarily be tomorrow’s as well.

Historic performance – a portfolio diversifier

The interesting aspect about this hedge fund ETF is its portfolio diversification capabilities and lack of correlation to traditional risk factors. The fund was up substantially in 2022 when both equities and fixed income got shafted. To that end, we built a 60/40/20 Equities/FI/DBMF portfolio in the ‘Portfolio Visualizer’ tool to better understand correlations and performance.

The correlation matrix highlights the benefits of DBMF:

We ran the portfolio from Jan 2021 to Mar 2024, with the above results. The fund’s correlation to equities and fixed income is negative, highlighting its usefulness as a diversifier. To better visualize the benefits, let us look at annual results by asset class:

DBMF was up in both 2021 and 2022 when fixed income was down, all while recording a negative performance last year when equities outperformed. Versus a traditional 60/40 portfolio, the fund provides for lower correlations and volatility.

The vehicle is up +13% year to date, and given its positioning we feel it will continue to outperform this year, as more market participants pile into one of its largest holdings, namely gold.

The take-away from this section is that DBMF acts as a diversifier, being up when equities and fixed income were down, and recording a positive performance so far this year.

DBMF is a portfolio diversifier, not an asset class on its own

Just like any hedge fund strategy, DBMF should only represent a small allocation in an investor’s portfolio, ideally alongside equities and fixed income as a diversifier. Sitting in 50% cash and 50% DBMF would not be an ideal choice, since the fund is not an asset class on its own.

Black-box investing like DBMF should always represent small allocations in a portfolio, and cannot be done in isolation from the traditional risk factors that a portfolio should contain. We view a 401k allocation as ideal, as the fund has proven itself in reducing standard deviation and volatility across time periods, all while providing for a positive long term total return.

Conclusion

DBMF is an exchange-traded fund. The vehicle falls in the hedge fund replication strategies bucket, taking long or short positions across equites, fixed income, currencies and commodities. The fund has a very low correlation to traditional asset classes, and represents an ideal portfolio diversifier, especially for a 401k account. The fund was up significantly in 2022 when both equities and fixed income were down. The risk factors for the name can change substantially over time, and the mandate is very wide. The fund is currently long gold, equities and WTI via futures, all while short 2- and 10-year bonds. Up already +13% this year, we expect the fund to continue to outperform.