In a time of higher inflation and increased market volatility, equities and bonds now increasingly move in correlation. It creates vulnerability and challenge for traditional 60/40 portfolios lacking non-correlated exposures.
Andrew Beer, co-founder and managing member of DBi, talked portfolio challenges and the benefits and evolution of trend following recently on the Top Traders Unplugged podcast.
The fundamental challenge that 60/40 portfolios face is one of correlation. In the 2010s, stocks and bonds offered inherent diversification because they carried a negative correlation to each other. This is due in large part to the Fed put in the markets that artificially dampened volatility. With that Fed put down, markets are resuming more traditional patterns. This includes more periods of stock and bond correlation.
“The evidence is building up that 60/40 portfolios are broken,” explained Beer. “If you go from the sweet spot of the Fed put era in the 2010s, a 60/40 portfolio in the U.S. had a standard deviation of around six percent. It’s 12 now!”
While there haven’t been the sharp drawdowns in equities that happened during the Great Financial Crisis, today’s standard deviations align with those experienced during the GFC.
It’s a reality that the financial industry is slow to acknowledge. The reason? According to Beer, it’s hope.
“This whole year from a macro perspective has been to just hold on and hope, with a white-knuckle grip,” Beer said. It was a hope “that we go back to the 2010s because then everything was working the way it was supposed to.”
The Most Valuable Asset Allocation for 60/40 Portfolios
If the fundamental challenge for 60/40s portfolios is that of increased stock and bond correlations, the logical solution is diversification. This in itself can be a challenge, however, as many alternatives often carry a high level of correlation to either stocks or bonds.
Enter managed futures, which performed predicably poorly during the 2010s in an environment of artificially reduced volatility. Now that volatility and inflation are back, however, trend strategies are proving their worth.
“The narrative around managed futures has gone through a couple shifts,” explained Beer. In 2020, the strategy was believed largely to be a dead one. However, that began to shift in 2021 and became more pronounced in 2022 in the wake of equity and bonds both falling simultaneously.
Some argue that managed futures and hedge fund ETF conversions are undergoing commoditization (distilling individual or diverse strategies into more standardized versions). Beer believes it only creates benefits for broader investors, allowing easier access and lower fees.
“What ’21 and ’22 showed was that even with compression of fees, dissemination of information, etc, the space is still structurally the most valuable asset allocation you can put in a portfolio of stocks and bonds,” Beer said.
Invest in Managed Futures With DBMF
The iMGP DBi Managed Futures Strategy ETF (DBMF) offers a noncorrelated return stream for portfolios to stocks and bonds. It’s a strong portfolio diversifier and could prove a boon in times of equity and bond correlations and elevated volatility. In September when stocks and bonds both dropped for the month, DBMF gained over 4%.
The fund is actively managed and uses long and short positions within futures contracts primarily, as well as forward contracts. These contracts span domestic equities, fixed income, currencies, and commodities (via its Cayman Islands subsidiary). Because the strategy transacts in futures, it offers a low to negative correlation to stocks and bonds.
The Dynamic Beta Engine determines the position that the fund takes within domestically managed futures and forward contracts. This proprietary, quantitative model attempts to ascertain how the largest commodity-trading advisor hedge funds have their allocations. It does so by analyzing the trailing 60-day performance of CTA hedge funds and then determining a portfolio of liquid contracts that would mimic the average of the hedge funds’ performance (not the positions).
By offering the hedge fund strategy in an ETF wrapper, DBMF can generate “fee alpha” through significant savings in fees compared to a 2/20 hedge fund fee structure.
DBMF has a management fee of 0.85%.
For more news, information, and analysis, visit the Managed Futures Channel.