DBMF - CTA: The Simplify Managed Futures Strategy ETF Is A Solid Portfolio Diversifier

2023-03-08 14:11:36 ET

Summary

• The CTA ETF has impressively outperformed managed futures strategy benchmarks in its first year since the fund inception date.
• The fund distributes a monthly dividend that yields above 6% on a forward basis.
• CTA is a good option to capture exposure to this alternative investment class which can work as a portfolio diversifier.

The Simplify Managed Futures Strategy ETF (CTA) utilizes a long/short investing approach across a basket of commodity and rates futures. The attraction here is the standard exchange-traded fund structure for a strategy traditionally connected with "commodity trading advisors" and institutional investors. The recognition that the managed futures have a low correlation to stocks and bonds allows CTA to work as a portfolio diversifier in various market environments.

At the one-year anniversary of the fund's inception date back in March 2022, the performance thus far has been impressive with CTA returning 18% over the past year. Income investors will appreciate the monthly dividend schedule, which currently yields above 6% on a forward basis. Overall, there's a lot to like about CTA and this article highlights the themes to watch going forward.

What is the CTA ETF?

CTA is actively managed, meaning it's not intended to follow any underlying index while each position is at the discretion of the portfolio management team. In this case, the fund delegates the investment advisory to "Altis Partners" deploying a series of systematic models between "price trend", "mean reversion", "carry", and "risk-off" depending on the market conditions.

The idea with a systematic long/short strategy is that the process has rules in place to enter and exit positions based on any number of proprietary inputs. While the actual parameters of the CTA fund are not disclosed, trading is often driven by quantitative relationships and pricing trends between markets. Compared to "discretionary CTAs", the systematic approach is intended to remove human emotion. Ultimately, the objective here is to generate long-term capital returns through an absolute return profile.

There is strongly academic and historical evidence suggesting managed futures have a low correlation to stocks, bonds, hedge fund returns, and even commodities as a group. The reason for this is that with the flexibility to be both long and short in various different markets, the expectation is to capture bullish trending markets while limiting downside volatility in a risk-off scenario. The relatively unique exposure, return, and risk profile make managed futures into their own alternative investment class.

The key point here is that while there are hundreds of commodity trading advisors and managed futures funds, the CTA fund is one example that is accessible to investors as an exchange-traded fund.

So when looking at the universe of available futures and markets CTA is trading, the fund will hold anything from U.S. or Canadian energy, agriculture, grains, metals, and rates futures in both long and short positions.

From the latest portfolio update , we find net long positions in markets like crude oil, live cattle, and sugar while short gold, copper, when and short-term treasury rates futures. The exposure is further collateralized with a smaller cash position and treasury bills. The caveat here is that the positions are subject to change at any time.

Finally, we can mention that CTA has been distributing a monthly dividend since August 2022. The regular quarterly rate of $0.15 per share is expected to reflect the portfolio's ordinary income based on the future carry and interest received. At the same time, it appears CTA also made a larger year-end distribution of $1.11096 based on the long-term capital gains component from realized sales.

It remains to be seen if this schedule will remain consistent going forward. Just assuming the $0.15 monthly payout, a normalized forward yield above 6% should be expected through 2023.

CTA ETF Performance

We mentioned CTA has had a strong performance thus far with its limited trading history, up 8% year-to-date. Here we can draw a contrast to a group of alternative "managed futures strategy ETFs" that has turned into a growing market segment of ETFs.

CTA, up 18% over the past year, has managed to outperform the iMGP DBi Managed Futures Strategy ETF ( DBMF ) and the KFA Mount Loucas Strategy ETF ( KMLM ) with a 12% and 11% return each, respectively. There is also the lagging WisdomTree Managed Futures Strategy ETF ( WTMF ) down -7% over the period and the First Trust Managed Future Strategy ETF ( FMF ) was essentially flat over the period.

The chart below also includes the Invesco DB Commodity Tracking ETF ( DBC ), which simply holds a long-only basket of commodity futures, down -11% over the period.

The other dynamic to consider is that CTA also had a lower max drawdown than peers as a risk metric improvement. If we go through each of these funds, they all have unique aspects to their strategy and also cover different markets. For example, KMLM trades in FX futures while also distributing a largely monthly dividend. All we can say is that the early results are encouraging for CTA on the total return side.

To be clear, there's simply not a long enough trading history to make a statement suggesting CTA is "the best" of the group or will continue to outperform indefinitely. The future performance will depend on the successful execution of the strategy by the management theme and the underlying quantitative models.

Final Thoughts

CTA is a quality fund that can work in the context of a more diversified portfolio. Amid ongoing macro headwinds between the uncertainty of inflationary trends and the direction of monetary policy, a managed futures long-short strategy is well-positioned to stand out. CTA does a good job of capturing the high-level themes of this alternative investment asset class.

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