DBMF: Lagging At The Turns

ETFS

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A few months ago, I wrote an initial positive article on the iM DBi Managed Futures Strategy ETF (NYSEARCA:DBMF). I was one of the first analysts providing thoughts on the fund.

While DBMF’s YTD returns remain strong, if the main trends that the fund had been betting on are inflecting, then DBMF may see a bout of underperformance as its ‘Dynamic Beta Engine’ needs a few months to recalibrate to new trends. I think it would be prudent to reduce one’s holdings in DBMF and wait until new macro trends develop.

Strong Performance Coming To An End?

Since my article, we initially saw good performance in the DBMF ETF, as its main positions were large currency bets against the EUR and JPY. The US dollar continued to rally significantly against the EUR / JPY on the back of divergent monetary policies between the Federal Reserve and the ECB / BOJ. The Fed was intent on raising interest rates to combat inflation, while the ECB was slower to raise interest rates and the BOJ was adamant in holding onto easy monetary policies (Figure 1).

DBMF price chart

Figure 1 – DBMF performed well until October (stockcharts.com)

However, the strong US dollar trend came to a violent end in October, as the Federal Reserve started to float the idea of a step-down to a 50 bps hike at the December FOMC meeting, while Japan spent a record $43 billion to prop up its currency.

Figure 2 shows the price chart of the EUR vs. the USD, and figure 3 shows the JPY vs. the USD. In both cases, we saw the currency pairs reverse violently, taking out months of gains as many macro traders (including many CTA strategies) were stopped out of their trades.

EURUSD saw a trend inflection in October

Figure 2 – EURUSD saw a trend inflection in October (stockcharts.com)

USDJPY saw a trend inflection in October

Figure 3 – USDJPY saw a trend inflection in October (stockcharts.com)

I warned of this JPY intervention risk in my article on the ProShares UltraShort Yen ETF (YCS), and personally exited my long DBMF position as the two currency pairs inflected.

Unfortunately, it appears the DBMF ETF is a bit slower to react, and is still short the EUR and JPY, as shown by its latest holdings report (Figure 4). Note, DBMF is short 66% of the portfolio in the EUR via EDH4 and ECZ2.

DBMF holdings, November 22, 2022

Figure 4 – DBMF holdings, November 22, 2022 (imgpfunds.com)

Dynamic Beta Engine Lags At Inflections

The problem with DBMF is that its ‘Dynamic Beta Engine’ is backwards looking and is slow to react at inflection points. I warned of this risk in my prior article: (author highlighted the key sentences for emphasis)

In my opinion, the biggest risk with the DBMF ETF is the ‘black box’ nature of its proprietary ‘Dynamic Beta Engine’ and the size of its bets. Notice from Figure 1 that DBMF currently has a 44% net short in the Japanese Yen, and a 28% short in the Euro. These are very concentrated currency bets, if the Yen and Euro were to go against the Fund, losses can pile up quickly.

Furthermore, DBMF’s ‘Dynamic Beta Engine’ is backwards looking, as it analyzes the trailing performance of the largest CTA hedge funds to identify performance drivers and construct a replicating portfolio. If markets were to inflect and the CTA hedge funds change their positions, there may be a significant time lag before DBMF makes the same changes, as the sub-advisor does not have discretionary power to overrule the engine.

Are Treasuries The Next Short To Squeeze?

Looking through the holdings report, we can see that the DBMF is heavily short long-term treasuries, to the tune of 50% of the fund across 4 positions. Unfortunately, it appears long-term treasuries are also reaching an inflection point, as investors start to price in a 2023 recession (Figure 4).

10Yr Treasury Yields peaking

Figure 5 – 10Yr Treasury Yields forming a bearish wedge pattern (Author created with price chart from stockcharts.com)

Investors May Need To Wait For New Trends To Develop

While DBMF’s YTD returns remain strong, with YTD and 3 Yr average annual returns of 34.8% and 14.9% respectively to October 31, 2022, recent performance around the trend inflections do highlight the weakness in DBMF’s strategy (Figure 6).

DBMF strong YTD returns

Figure 6 – DBMF strong YTD returns (morningstar.com)

Conclusion

While DBMF’s YTD returns remain strong, if the main trends that the fund had been betting on are inflecting, then DBMF may see a bout of underperformance as its ‘Dynamic Beta Engine’ needs a few months to recalibrate to new trends. I think it would be prudent to reduce one’s holdings in DBMF and wait until new macro trends develop.

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