ETF Edge - Alternative Asset Plays – Commodity & Hedge Fund ETF Exposure 11/7/22

Episode Date: November 7, 2022

CNBC’s Bob Pisani spoke with Andrew Beer, founder of Dynamic Beta Investments and co-portfolio manager of DBMF – along with Andrew McOrmond, Managing Director at WallachBeth Capital. They took a look at one of the best-performing ETFs of 2022 – delving into alternative asset plays and offering ETF investors exposure to key commodity-tracking hedge funds that specialize in trading futures contracts. The fund has been on fire all year long – they break down what’s fueling the gains. In the Markets ‘102’ portion of the podcast, Bob continues the conversation with Andrew McOrmond from WallachBeth Capital. Hosted by Simplecast, an AdsWizz company. See https://pcm.adswizz.com for information about our collection and use of personal data for advertising.

The ETF Edge podcast is sponsored by InvescoQQQQ, supporting the innovators changing the world. Investco Distributors, Inc. Welcome to ETF Edge, the podcast. If you're looking to learn the latest insights on all things, exchange traded funds, you are in the right place. Every week, we're bringing you interviews, market analysis, and breaking down what it all means for investors. I'm your host, Bob Pizzani. Today, on the show, we'll take a look at one of the best performing ETF to 2022, delving into alternative of asset plays and offering ETF investors exposure to key commodity tracking hedge funds

to specialize in trading futures contracts. I'm talking about commodity trading accounts, CTAs. The fund has been on fire all year long. We'll break down what's fueling those gains. Here's my conversation with Andrew Beer. He's the founder of Dynamic Beta Investments and co-poreal manager of DBMF, along with Andrew McGoherman. He's the managing director at Wallach Beth Capital.

Andrew, this is quite remarkable. 30% this year up. I've heard people say this could be the ETF of the year. Now, you're aiming to emulate the performance of 20 CTA hedge funds. Explain to us very briefly what CTAs do. What's in this? And why are we outperforming? Sure.

So I think simplistically, CTA hedge funds try to capitalize on big shifts in the market. And right now we're in the middle of a huge regime shift. We went from this low inflation world to one with high inflation. And the markets have spent two years adapting to it, try to figure out what's going on. And so what CTA hedge funds have been doing and they're having a historically good year is as inflation comes back, they're finding different ways to make money on it. And so what we do in our ETF is basically try to understand what trades they're doing and then to copy it in a low-cost efficient way in an ETF to bring access to that to a broader base. I want to clarify a couple things. First, even though they're called commodity trading advisors, they can invest in anything, right?

They don't have to be just commodities. That's sort of an old-fashioned name. They can do anything, essentially. Yeah, I think the modern term is managed futures, and it's because they invest in futures contracts. In regulatory land, futures contracts are often treated as commodities, but we call them managed futures. And you're not directly investing in any hedge funds.

I want to make that very clear here. You're using long and short futures contract to try to emulate the returns, right? Sure. So if they're betting on crude oil going up, no one goes out and buys barrels of crude oil and throws it into their garage. you buy a futures contract on it. When we see that the hedge funds are doing that, then we simply do the same thing.

We ourselves buy a futures contract. What is amazing to me was just looking at your positions right now. I mean, you're long crude oil, but you're short just about everything else. Euro, you're short gold, you're short the yen, your short two-year treasury notes. It's like shorts right across the board. It's really rather remarkable. We have been in crash protection mode, and that's been the right place to be.

Yeah. You know, Andrew, Andy, I'm going to call you, Andrew. I'm going to call you Andrew here. Everything's going right for these active managers, but only if you got the inflation trade right. So there are commodities up, rates up, dollar up. If you got that inflation trade right, then you're fine. But if you didn't, you're not fine. Well, here's where I look at it.

If, you know, an alternative asset of fund like this is diversification in a passive bull market. And you should have it. You don't expect that performance. You just have diversification. And then they shine in a market like this when they have their chance. It might be every 10 years, it might be every two years, but that's why you have it in place so you can outperform your beta and get some alpha when the market calls for. That's what they're good at.

That's why it's there. Yeah, you know, this is a really great example of the power of ETFs. You know, one of the things I can't stand about this asset class, about hedge funds in general and CTAs is they're very hard to access for people, and they're stupidly expensive. They typically charge, you know, 2 and 20 here, 2% of the fees. 20% of the profits. This guy's running this for 85 basis points. Right, but also,

0.85%. Let's not forget that you have to be, if you're an individual, you've got to be accredited to access one of these hedge funds. You just say, hey, they'll put 20 grand into it. So accredited is a big thing, liquidity. And this is the big point, right, on this part of the show, we like teach everybody what to do.

Do not try to emulate this strategy on your own, you know, with futures contracts using your e-trade. You just really shouldn't. And that's what's so great about, like, the power of ETS. It's giving you access to an I, let the professional trade it. Right? The SB 500, ETF, okay, it's only hard because you can't go buy

500 stocks, but otherwise you could probably emulate an index with a few big names. This is not the case in this. It's an alternative asset where the pros need to do their job. He's offering it to for 85-bips. But, Andrew, I want you to clarify, this says it's actively managed. To what extent is it actively managed here?

There's a model. You have a model, right? So you're looking at 20 CTA funds, right? right? Suppose you're aggregating like the majority or long oil or short oil, you're aggregating this and then you have a model, right? So to what is, is that active management? Yeah, so each of those CTA hedge funds has their own models and their models are trying to determine whether oil is going to keep going up, gold is going to keep going down, the dollar is going to keep getting stronger. Our models just figure out based upon recent history how they're positioned. Now, the reason it's called active is that even though the performance of it is very index-like.

So when you say what is an index in the managed future space, there's no S&P 500 you can point to where it's easy to invest in. Rather, what you're saying is what is a large collection of guys who pursue the strategy, how have they done on average? That's what an index means in this space. And so we're actually somewhere between passive and active and that we are trying to give you index plus performance by virtue of the fact that you get diversification by virtue of the fact that we're looking at a lot. lot of individual managers and the plus comes from cutting out fees. Yeah. So you have a model on top of a model essentially. Models on top of different kinds of models that are out there, right? Exactly. Our model is the best way that we found to figure out today how these guys are positioned.

We believe in the intelligence, the acumen, the sophistication of these guys. We just want to be able to copy what they do cheaply. And these models don't all agree with each other. Some might be long oil, some might be short oil, right? And you're aggregating that, essentially. Right. And that's been the current. of investing in the space. When you talk about the people in the real different, right? So it's like saying, I want to invest in emerging markets,

but you've got a pick between Brazil, which is having a good year, China's having a terrible year, India, etc. But you need somebody to put all that together to you. And what we basically do is say, here's emerging markets, the equivalent. You know, Andrew, I cannot figure out how the hedge fund business survives. I really don't.

I've been at CNBC 30 years. I've watched this industry, and it amazes me. How do they keep convincing people two and 20 is worth doing. How do you go to a pension fund guy and say, hire us? Or how does, how do they keep selling themselves based on this, at least at 85 basis point, you see what's going on here. It's pretty transparent. Well, there's a portion of, let's just, you know, what it is, business is business, and there's people being paid to go and outperform Bader or outperform the SAB 500 or outperform a Vanguard fund. That's part of it. But I also think any sophisticated investor is

going to take maybe, let's say, 80% of his money and put it in this and take a shot at 20%, right? Or take a shot at 5% in an alternative hedge fund. If they hit that home run, if you get that 80%, that 150% return in a given year, you're not going to worry so much about the 20% going back. Tell us practically how this really works, how this sale really works. And you were in the hedge fund business for years, right? So I'm a pick XYZ, you know, teachers fund annuity from wherever, pick state, and I have advisors, right, to tell me where to do my asset allocation, right? And they're trying, is it the advisors who tell you you need to hire hedge funds to get some alpha here?

How does that work? I mean, what? So, look, like any part of the active management business, as Andy said, there is an industry around manager selection. And the industry around manager, you ask, how did these survive? It's because, look, look at our space, right? There are guys who are up 100% this year. and guys were down 30% this year, within the same space.

So there are always guys who look like they can do no wrong. And I think the big lesson of the past 15 years has been the guy who did really well last year is just as likely to have a horrible year. This is Vogel's central insight. There is no pattern. Well, the pension is not going to hire 10 of him in each different asset. The point here is the people who make out well are the advisors who collect fees, of course, and the hedge fund. So you're an advisor to, you know, X, Y, Z, teachers annuity fund and wherever,

and the advisor is telling them you, the pension fund is freaked out because they don't have enough to cover their potential liabilities in the future. Right. And so, so the best allocators that I know in this space, right, have a formula for success, which is they recognize that they don't know who's going to do well next year, so they spread their bets. And if they're really big, like a sovereign wealth fund or a huge pension plan, they don't pay $2.20 like everybody else. They're going to go in and say, I've got a billion dollars, but if you want it, we're not going to talk about a full fee structure. Those guys always outperform the average. And in a sense, what we've tried to do is emulate

that model, but in an ETF with low-feas accessibility, etc. So everybody can get it. You don't have to be an enterprise client. Yeah. Yeah. Well, what's fascinating to me is just that they can keep selling this year after year, this model, where everyone does well, except the clients back and forth. I mean, long term, we don't see any evidence that hedge funds outperformed. But the same thing has also happened. There's a world of hedge fund strategies that are in mutual funds and have been in mutual funds for 15 years. The same thing happens there. You're an RIA. You're running your business and you start getting calls from a salespeople. You know, we've got a fund that's up 10% this year. It's up 10% last year. It's up 10%. You don't hear about

the dozen other funds that haven't done well. The overall Liquidalt's world has done less than 2% per annum for the past decade. Yeah. Define liquid alts for people. Sure. So these are hedge fund strategies that, so alternatives that are put into mutual funds and very rarely but occasionally into ETFs that are basically hedge fund strategies, but it's liquid because you can get in and out of a day or. Yeah. What classes would you see?

So there's equity long short, there's managed futures, there are certain... Your ETF is a good example? Are it? So, so... Liquid alts are not like real estate. for example, Timberland, for example, or it could be a reet, but Timberland is not a liquid all. Everybody has their own definition of it. There are publicly traded reits out there. Some people call them alternatives. When I use that term, I'm talking about hedge fund strategies,

so the stuff you would see in your proverbial institution, but somebody has taken one of those strategies and put it into a mutual fund to democratize it. To me, liquid means, I don't want to get too technical, but I don't want to use words that the viewers, unless it may not know, liquid means easily bought and sold. I can get in Monday and get out. Timberland is not a liquid all. No, and a hedge fund will typically say you can get out next quarter. And things could, like, hey, I need the money.

I'm building a house. Like, next quarter, that means not liquid. Right. And the reason people have focused on it so much in the hedge fund world is that in the great financial crisis, you thought you could get out of hedge funds and you couldn't. So you thought, oh, I can get my money out next month. And it turns out it took you three or four years to get your money back. Yeah.

And so a lot of it. Because it wasn't liquid because they couldn't sell at the prices they wanted. Private equity, private equity. The company's not going to let you sell their shares. You might be in it for six years. I don't want to call that liquid alt either. Yeah, either. Yeah.

So again, it's a terrible term, because as you described it, it's vague, but what it describes is a mutual fund, right? And it's all about, and the point that I've made is when you have this area where you've taken these strategies run by really, really smart guys, and it hasn't done well for investors, it calls it a question why you would want to democratize the space in the first place. And so what we've been trying to do is actually in our, the 15-year history of my partner, Matias, and my effort have been to say, look, actually most ways aren't going to work, right? Just recognize most things you can do as a hedge fund.

You can't do in a mutual fund. You can't do it an ETF. But what works and what works really well and focus on that? Yeah. Now, I want to move on and show you another ETF that you run. This one's not a CTA, but it's a hedge fund, ETF. It's hedge strategy, EETF. The symbol is DBEH.

and that models the performance of 40 long short equity hedge funds. So this is long short equity hedge funds. This is different than CTAs. And it uses futures contracts. And explain how this works. We put a screen up here that shows you a little bit. Yeah. So our insight into, so when you talk about this category, it's called equity long short.

And the idea is really, really smart guys are going to know not just what stocks to buy, but what stock to short, which means bet it's going to go down. Right. And so you're giving them basically two swords as when they go into battle. Our conclusion was that most of what they get right are big shifts in the market. They get off the tracks as the train is coming down. They shift into, you know, when interest rates start to go up, they shift from fang stocks that are dependent upon low interest rates to more interesting value stocks or vice versa. They go into emerging markets at the right time. And so what we do is we look at, again, a large pool of funds.

We're not trying to tell you whether they own meta versus Alibaba versus Semex or anything else. Rather, what we're saying is let's get those big factor shifts right. They're called factor shifts. And if we get that right and put it into an ETF, we've given an allocator a really valuable tool because it's less risky than equities, but can generate equity like returns over time. But too seriously, this is the same strategy as the first fund that we talked about, which is your aggregating models essentially, right? So on aggregate, if this pool is long, these 40 hedge funds are long Apple,

3%, you're going to try to emulate that, right? Absolutely, except we don't do it with Apple. We would do it with a futures contract on NASDAQ. And again, our entire business, the only way we found to do this well, and by this, I mean, get the diversification benefit. Well, 40's a lot. 40's a lot. That's right.

I mean, that's good. But how do you get the diversification benefits of those 40 hedge funds that you cannot otherwise access, but in an ETF with trading efficiency and all these other features, is to figure out their big trades. But you say you're using a NASDAQ future, you wouldn't be individual stock futures. You're talking about, you would. Overall NASDAQ, right? So if we see them in Fang stocks, for us, that's a NASDAQ futures contract.

It's not a series of individual stocks. Yeah. Big trades. Yeah. So, and explain what the cost is for this, too? Also 85 basis. Same cost structure overall as them as well. Right.

And so what we're trying to do is there are thousands of guys out there who run ETF model portfolios, which means stocks, bonds, and other stuff. But they're not short. Well, and so what we're trying to basically say is, look, going forward in the 2020s, you have a different need, right? 60, 40, and being long stocks and bonds entirely get incredibly well for a decade or more. It's a different world right now. Correct.

And so we're trying to give you the building blocks where you can say, I want this much of this strategy, want that much in that strategy, and it's as simple as investing in an S&P 500 ETF. That's what we're trying to do. Now, you also, I want to go back to the managed future, DBMF, which is a simple, we're just as much DBMF we had talked about earlier, you pay a very large dividend on this, right? Wasn't it last year you played a 10% dividend? Exactly. And explain how that happened, and this was a taxable event, wasn't it?

Sure. So one thing to be very clear about the two ETFs that we run is that there, so if you do an S and P500 ETF, there's a big tax advantage relative to mutual funds in general. There is no big tax advantage in running an ETF with these kinds of strategies. So what happens is when we make $10 around the end of the year, there's going to be a dividend of the gains in it. Depends upon a lot of other criteria, but last year, the ETF was up, I think, 11% or so, 11.5% of the gain year to date. So as an investor, you're going to see a lot of that coming back as a dividend. So just when you look at the performance of these strategies, you need to factor into it that the income that you receive over time is going to be taxable as it would.

Explain why it comes back as a dividend. That's what I think a lot of people want. Yeah. So in futures contracts, any mutual funder ETF that trades futures contract recognizes all the gains on December 31. Okay, so that's the answer. That's the answer. That's the answer. Let's flatten out the actual fund. Yeah, it's the future.

It's the nature of the structure. It's the product. It's the structure of the product. It's the future contract. You have to pay them out at the end of the year. So that's the simple answer. I was trying to get to that to the viewers. It's not obvious.

See, you understand that intuitively. Like I'm getting yield. But you are. Just pay taxes on it. Because you're trading futures contracts. That's the short-end. It's future contracts. Yep.

And there was a drop in the fund at the end of December on that last year. And your point is you have to, it was distributed as a gain. Sure, right. So you have to really look at the total return. Like if you just look at the price return, it's not really truly indicative, right? Absolutely. You've got to look at total return. And there are some databases out there that when you pull up the returns of it,

it looks like every December it suddenly drops. that's not real, right? That's like saying I was in a bond and I got a big coupon out of the bond, but I don't treat the coupon. Not even acting like it was there, yeah. It was there. So, yeah, so you have to configure,

if you're going to look at it, you have to look at total return. You can see that in fact sheets. You can see that on the websites. Okay. Well, you can see, this is a fascinating subject. I love talking about hedge funds, but more importantly,

ETFs provide an easy way to get into this kind of strategy. It's cheaper, it's more efficient. This is what ETFs are all about, whether you like or don't like, hedge funds are CTAs. Now it's time to round out the conversation with some analysis and perspective to help you better understand ETFs.

This is the market's 102 portion of the podcast. Today we'll be continuing the conversation with Andrew McCormon and Wallach Beth Capital. Andrew, thank you for sticking around. We had been discussing hedge funds and hedge fund ETFs out there a few minutes ago, but I wanted to get your broader thoughts on the market. One of the things that's pretty obvious to me is the foreign markets are getting killed this year, particularly emerging markets. You're a trader. You get people calling you all the time asking for trading ideas. What does 2023 look like for emerging markets? I think it's going to be time.

I think it's time to start, probably putting some money into that. And it's really not so much about what's happening over there. It's about, aren't things depressing over here? And we really haven't hit, I haven't seen that spot where everybody. And I mean everybody, you know, like the guy in the post office is like, stocks are terrible, you know, that's usually the competition. situation point, just like on the upside when everyone's like, you know, when your babysitter's making money trading stocks, you know it's time to get out, right? Yeah. We're not out that at the bottom.

I think if you're just coming on the U.S., Bob, I think the problem is we continue to struggle. The real economy lacks the stock market, right? Inflation's still out there. I was listening to the program, not yours, but, you know, on CBC, and they were talking about we just really need to see job losses. And like, you know, where are we that were hoping for job losses? It's pretty depressing. Yeah, it's depressing.

And they're all, and like, so the job losses are going to come, right? They were, the show was spot on. Since I saw that on TV last week, Jabba, Amazon, meta, we're laying off, we're laying off, we're laying off. And that also takes a time to roll itself through spending and credit cards and those things that will. So I think we're still in quite a bit of trouble in the U.S. for, let's say, another six months or a year. But you want to go back to emerging market. So there's the, yeah. They've been underperforming all year dramatically.

But is that by itself a reason to do that? I mean, I know people like you, the value guys, and they'll say, okay, I don't care about China, but when it's 14 times forward earnings and below, I'll buy it because historically, it usually gets a bounce. Right. That may be true. It's probably right around there for China right now. There are other considerations out there about whether China's investable or not. I mean, these debates around emerging markets of China in particular have really changed a lot in the last few years,

as Chinese become more of an ideological opponent to the United States. I used to say, yes, I think there is a higher degree of political risk around this than there used to be. And I used to be like you. I used to say, well, okay, if China's pick a number, 15% of global equity market capitalization, then you ought to own a foreign fund that has China representation in it. Clearly. Other people were value guys who said, I'll go in and out. But the debate about whether or not there's an ideological component, there's a political risk component that's a lot higher than we thought is fairly new.

It's only in the last three or four years. And there's obviously volatility around when you're speaking one about China, right? But politics is now in the U.S. Not, of course, not nearly the same volatility, right? Because we're a democracy. But there's certainly the current political landscape in the U.S. is depressing. Everyone at least agree with that. Because it's either way are you coming out like, this will cause a great bold?

But depressing in the sense it's so divisive. Yeah, and it's divisive, and you just don't see what it goes either way. If it's going to be great for the market because there's not going to be like this come to Jesus moment, where I'm like, thank God this party one or this party one, right? Unfortunately, probably still stayed a little divided. But back to the emerging markets, you know, I was going to talk about an ETF that Victory have, which is UEVM, which is value and momentum, right? So versus just picking a country, let's say, which was the old way to do it,

I shares, has all the countries. They're fabulous ETFs. You can pick any country you want, but man, is that hard to pick the right country right now, right? So a diversified emerging market where you kind of damper the political risk, and the victory product is going to actually pick the greatest value, which should help risk. And the symbol there is U VEM. UEVM, Uncle Eddie Victor, Mary, UEVM. UEVM. Yep, UEVM.

And it has a 7% dividend, which is great, but it picks value stocks. Seven times earnings is the average stock that trades in UEVM. I want to move on and ask. about ETF trends this year and one of the things it seems to me is like the traditional

mutual funds converting to ETFs is finally getting some traction you know Dimensional started that a couple years ago and it seems to have

accelerated this year yeah we've never seen it like this month I mean so they what have we seen this month well so dimensional is an example

right we saw a big trade just recently that was literally out of the dimensional mutual funds into the ETFs So what makes them so unique is that they are the private club of mutual funds, right? You know, there's no guarantee that your RAA or your financial bodies could get you into a dimensional fund.

It was always kind of like an invite thing. So when they came out with the ETFs, it was like, wow, they're opening their playbook for everybody. And, you know, I think it's a fabulously run company, fabulous ETSs. I think they kind of held on to that aura for a while. And people are like, well, I want to be in the mutual fund. And all of a sudden, you're starting to see that. We did see a change. We saw that big trade.

Franklin Temple, those are the managers we're talking about, right? Like, you know, Vanguard always had their second class of ETFs, and it goes to such a value crowd that both were positive. But when you see Franklin Temple, there's been out of ETS for years, starting to gain traction, because it was such an institutional mutual fund shop versus retail. I think that's a big trend. Obviously, flows up across the board,

but I didn't think we'd see the day where you saw the traditional mutual funds that are for institutions, Make some hay in ETFs, and they are. And you're an ETF trader. So people who want to move ETFs call you up for due trades. Have you been seeing anything recently that is interesting or out of the ordinary? High yield, again, it's interesting to see the high yield trades. You know, you think of them as risk, but remember that these traders are putting this on

as actually a conservative strategy to equities. When you said the high-risk trade, high-yield trade, do you mean you're seeing people buy buy and then subsequently sell because it's been a tough trade to get right. It's a way of getting exposure to the market, but not a lot of trend. Yeah, not a lot of trend. It's been a lot of up and down. So it's been tough to spot, but we've certainly seen an increase in that. Yeah, all that tells you is sophisticated traders are clueless too about trend.

Actually, what I think it tells me is that the market's trying to find footing. It's just been hard to be right. It's not that, hey, we're in cash and we're leaving it in cash. In the last quarter we've seen like, okay, it's time to get out of cash. It just hasn't always been right because we've had a little bit of a whipsaw. Yeah, all right. I'm going to leave it right there. Andrew, thank you for coming.

Andrew McCormon is the managing director, Wallach, Best Capital, an old friend of ours, an old friend of ETF Edge. And thank you for joining the ECF Edge podcast. InvescoQQQQQ believes new innovations create new opportunities. Become an agent of innovation. InvescoQQQQ, Invesco Distributors, Inc. Thank you.