Don’t Put All Your Eggs in the Interest Rate Basket | ETF Trends

Equities and bonds soared for much of this month on hopes of an end to interest rate hikes. That momentum paused on Friday after dampening comments from the Fed indicating interest rate cuts remain distant. The interest rate narrative is one that markets consistently get wrong. As such, investors should plan for alternative outcomes to the interest rate path in 2024.

Investors largely decided after October that inflation is well in hand under current Fed rates. Equities climbed and investors flooded back into longer-duration bonds after sitting on the sidelines much of the year. It’s an optimism that warrants caution, particularly in light of recent Fed comments. New York Federal Reserve President John Williams indicated Friday that the regulatory body isn’t currently thinking about rate cuts.

Markets Prove Unreliable Interest Rate Predictors

The diverging narrative of market predictions and the Fed agenda regarding interest rates is nothing new.

“The market has been wildly and consistently wrong about the direction of interest rates since 2010,” according to Andrew Beer, co-founder and managing member of DBi, in a recent video.

Chart of Fed Fund Rate Futures predictions from 2010 to current compared to the actual interest rate.

Image source: DBi and iMGP

Markets over the last decade have gotten the inflation narrative wrong, Beer went on to explain. Each year of the 2010s forecast rising rates, and yet each year rate hikes failed to materialize. When the pandemic struck in 2020, markets took the stance that rates would remain low for years.

When the Federal Reserve began to hike rates in 2022, markets incorrectly predicted each successive hike.

“The point is to be very skeptical when you hear people tell you where rates will be in a year,” Beer said. “Yes, there’s a chance that the next year will be smooth sailing… but it’s not likely and you might want to plan for stormier seas.”

DBMF Offers Diversification Regardless of the Interest Rate Path

November and the abrupt change in the interest rate narrative proved challenging for trend strategies and the iMGP DBi Managed Futures Strategy ETF (DBMF). The fund seeks to replicate the performance of the SocGen CTA Index, an index of the largest managed futures hedge funds.

Managed futures offer strong diversification opportunities as they hold low to negative correlations to stocks and bonds. In a year like 2022, DBMF soared. Now, as trends reversals dominate in 2023, the strategy has come under pressure.

“We often talk about DBMF as a beacon of green in a sea of red,” Beer explained of the strategy. “Last month we were a red blotch in a sea of green, but a sea of green or a sea of red should not be comforting to wealth managers.”

A portfolio with almost all its assets moving together is one lacking diversification. Beer explained that the S&P 500 and the Bloomberg Agg have a correlation of 0.85 this year. This creates the potential for fragility in certain environments in which stock and bond correlations rise, such as during high inflation.

At its core, DBMF offers consistent diversification regardless of market direction. The ETF is an actively managed fund that uses long and short positions within derivatives (mostly futures contracts) and forward contracts. These contracts span domestic equities, fixed income, currencies, and commodities (via its Cayman Islands subsidiary).

The position that the fund takes within domestically managed futures and forward contracts is determined by the Dynamic Beta Engine. 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 hedge funds’ performance (not the positions).

DBMF has a management fee of 0.85%.

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