One recurring theme in these articles over the past year has been the capability of the exchange traded fund structure to accommodate various investment strategies and asset classes. Over the years, what the industry refers to as an ETF "wrapper" has allowed issuers to go way beyond the simple long-only index-based equity products that launched this industry.
Even ahead of the substantial ETF rule changes made by the SEC in 2019, issuer IM Global Partner, which began life as Litman Gregory Masters Funds, joined a relatively exclusive club in ETF-land by launching the iMGP DBi Managed Futures Strategy (DBMF) .
Soon to join the club was the team of Krane Funds Advisors and Pennsylvania-based Mount Lucas Management, who among other things, manages the MLM Index, which they bill as the first systematic futures-based index. These partners launched the KFA Mount Lucas Index Strategy ETF (KMLM) .
Managed Futures 101
When you start talking about managed futures, you are moving into the world of alternative investments, otherwise known as "Alts". Alts usually conjure up visions of private equity, directly owned real estate (as opposed to exposure through REITs), infrastructure projects, and hedge funds. In other words, the land of high, ultra-high net worth, and institutional investors.
While stocks and bonds have portfolio managers, managed future strategies rely on Commodity Trading Advisors (CTAs). These firms have the same goal of generating alpha for their clients but do so through executing strategies using futures. The term CTA may lead you to believe that they focus on only hard (metals, oil) and soft (grains and livestock) commodities, but they also utilize treasury futures, index futures, and foreign exchange (F/X) futures. Think of them as go-anywhere investors that prefer to go anywhere there are futures. For a more in-depth look at managed futures, check out this tutorial at CME Group.
Both of these funds are on the high end of the expense ratio spectrum with stated 85 (DMBF) and 92 (KMLM) basis point expense ratios. Remember, 100 basis points is equivalent to 1% so a shareholder with $1,000 invested over a calendar year will pay $8.50 or $9.20 in fees over that period, depending on which fund they are holding.
As I've talked about in the past, basic equity and bond investing during tough times tend to limit investors to either trying to reduce the amount of pain their portfolio feels or going to cash and feeling nothing, except the effects of inflation.
Once you expand into the world of derivatives that spectrum of experience widens considerably. As is the case with any powerful tool, derivatives have the potential to create and destroy, and do either very quickly depending on the skill or lack of it, of the investor. As you can see from the below graph, both issuers of DBMF and KMLM seem to know what they are doing.
Source: FACTSET, All You Can ETF
Both funds track indexes although DBMF tracks what I would call more of a benchmark and KMLM tracks a more traditional index as mentioned earlier. DBMF is pegged to the Société Générale CTA Index which, per the latest rebalance announcement I found and this loose methodology, is a benchmark to me because index constituents are the top 20 CTAs and it doesn't seem like they release holdings for these portfolios. The "available for free" link in the description from the last link gave me a 404 Error on the Soc Gen website so clearly, they have put everything behind some kind of wall at this point.
As you can see from the table, below, DBMF has done very well this year on its current portfolio of treasuries, fed funds, currencies, oil, and equities. KMLM checks those boxes and also includes some commodity exposure with allocations to copper and a host of soft commodities which seem to be the defining distinction between these two funds.
One other difference between these funds is their correlation to equities. I calculated a correlation between the SPDR S&P 500 ETF Trust (SPY) and DBMF of 2.21% for the period of December 2, 2020, through October 7, 2022, which falls into the realm of "uncorrelated asset" in my book. KMLM correlation to SPY over that same period was calculated to be -13.94%, still very low, and offers an additional explanation for the additional bump in excess returns over this observed period given the slightly inverse relationship to equities.
Source: FACTSET, All You Can ETF
As you can see from the historical cumulative return graph above, both funds have been excelling this past year. DBMF earned a 4-Star rating from Morningstar as soon as it established its three-year track record which marked its eligibility to be rated, and soon after that saw that rating rise to the coveted 5-Stars.
Many brokers interpret these high ratings as a liability shield and retail investors as a seal of approval, which is evidenced by the fund's assets under management growing from $337 million at the end of June to just under $1 billion currently.
I would offer that proof, as they say, is in the pudding and my guess is that as soon as KMLM hits its 3rd anniversary, it too will receive a strong rating from the folks at Morningstar.
Both funds have been doing well so far during this regime change by providing exposure to financial assets and KMLM has provided an edge with hard and soft commodity exposure. Depending on your outlook, one of these is definitely worth a closer look.