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Diversification Across Asset Classes Matters in Trend-Following

Trend-following strategies gained ground with investors in the last few years when markets experienced noteworthy reversals and prolonged volatility. The importance of asset class diversification cannot be understated in trend-following strategies as it allows for better capture of trend reversals.

There are several ways to employ a trend-following strategy but managed futures arguably remain the most popular and well known, given their standout performance last year. Not all managed futures funds invest alike, however, some strategies excluding asset classes, miss out on the potential and opportunities of broad diversification.

Andrew Beer, co-founder and managing member of DBi and co-PM of the iMGP DBi Managed Futures Strategy ETF (DBMF), highlighted the importance of diversified exposure in a recent video. In his discussion of the fund’s performance, Beer elucidated the importance of diversifying asset class exposure in trend following.

Speaking about DBMF’s position in August, Beer explained the fund remained long the euro and short the yen. The short yen position is one of the fund’s most profitable ones both this year as well as in 2022.

“While other markets keep oscillating, the intransigence of the Japanese monetary authorities has been a gift to trend following,” Beer said.

Managed futures strategies generally invest across four main categories — equities, rates, commodities, and currencies. Not all strategies invest across all asset classes, making it important to understand what’s under the hood. DBMF invests across all four, expressed through 10-15 positions in the futures market.

See also: “Mind the Macro: The Decade of Portfolio Diversification

Long-Term Diversification Benefits Trend Following

DBMF is an actively managed fund. It 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.

Even when there are prolonged periods of stability and minimal deviation for the strategy to capitalize on, maintaining diversified asset class exposure is tantamount.

“Trend following in currencies was essentially dead money for years,” explained Beer. “In 2020 an allocator asked us to build a trend follower with no exposure to the space. We refused under the theory that dormant markets can suddenly become very ‘trendy’.”

Maintaining a position in currencies continues to pay off for DBMF and underscores the importance of diversification across asset classes. Since the fund’s launch in 2019, DBMF generated between 9-10% of alpha compared to the S&P 500. What’s more, Beer highlighted the fund’s 45% cumulative returns in times when bonds fell.

“It really shouldn’t be a question of whether a strategy like this goes into a diversified portfolio, but rather how much,” said Beer.

DBMF utilizes the Dynamic Beta Engine to determine 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).

DBMF has a management fee of 0.85%.

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

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// UPDATED ON 21/09
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