KMLM - Three 9+% Yielding ETFs I Own And So Should You

2023-04-08 07:45:00 ET

Summary

• Three of my favorite 9+% yielding ETFs had a terrible month due to the end of the worst bond bear market in U.S. history.
• Inflection points can be painful for this asset class because it takes two to three months for them to catch a new trend.
• 143 years of market history are clear; this strategy is highly valuable as a high-yield diversifier for most portfolios.
• For the last 53 years, combining bonds and this investment strategy has been the best way to generate great yield, strong returns, and super-low volatility, including during stagflation and market crashes.
• My $2.2 million family hedge fund is 22% managed futures but overweight bonds because that's what's most likely to allow us to meet our goals, which is to rebalance into 1-3 years' worth of stock buying during the coming bear market.

This article was published on Dividend Kings on Wed, April 5th.

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If you've read my work over the last year, you know I'm a fan of diversification, including stocks, exchange-traded funds ("ETFs"), bonds, and managed futures.

• Preparing For Recession Part 11: The Importance And Power Of Diversification .

This is what my family hedge fund looks like today, overweight long-duration U.S. treasuries and 22% managed futures in the form of KFA Mount Lucas Index Strategy ETF ( KMLM ), iMGP DBi Managed Futures Strategy ETF ( DBMF ), and Return Stacked Bonds & Managed Futures ETF ( RSBT ).

• 6 High-Yield ETFs For Up To 60% Gains In The Coming Recession
• why now is the perfect time to be overweight long bonds.

Deep Dives Into DBMF, KMLM, and RSBT

• Two 9+% Yielding ETFs I'm Buying, And So Should You
• RSBT: Why I Own This Potentially Life-Changing 12.4%-Yielding ETF .

Managed futures pay out all their gains over time in the form of annual dividends.

• 8.7% for DBMF (historically based on index returns since 2000)
• 9.4% for KMLM (historically based on index returns since 1988)
• 12.4% for RSBT (historically based on strategy returns since 2000).

I've gotten a lot of requests from Dividend Kings Members for an update about managed futures. Why? Because since the banking crisis, their performance has sucked.

Even four and five-star rated funds like Pimco's and AlphaSimplex have gotten crushed, and the best-performing managed futures fund of the year pre-crisis ( CTA ) has plunged.

What The Heck Is Going On? The Bond Bear Market Is Over

Let's remember what was happening on March 8th, the day before the banking crisis began.

Economic data was coming in hot, including a blowout jobs report in January. Fed Chair Jerome Powell was testifying before the Senate that rates would have to go higher than expected and possibly faster than expected.

The bond market was pricing in a 5.75% terminal Fed funds rate and a 50 basis point hike in March.

For 15 months, soaring rates had hammered bonds, and the single best trade was being short 2-year Treasury yields, the proxy for the Fed funds rate.

Guess what managed futures (called CTAs or commodity trading advisors in the industry) fund managers were doing? They were riding the strongest interest rate trend in 42 years, the one that caused the worst bond crash in US history in 2022.

Managed futures funds were -100% to -200% 2-year Treasuries, meaning the most short they've been since the early 1980s. And then this happened.

Overnight, Wall Street went from pricing in 1% more rate hikes to 1% rate cuts by the end of the year.

We were on the wrong side,” said Kathryn Kaminski, chief research strategist, and portfolio manager at AlphaSimplex. “This short-bond trade has worked for 15 months. At some point, trends break, and this could be the point.” - Bloomberg .

This seismic event caused the worst weekly loss for the Soc Gen CTA index in history (since its 2000 inception).

But notice in that chart how there are many periodic terrible weeks for managed futures. Those represent potential inflection points in the economy and financial markets.

Here's the CEO of DBMF explaining why these matter (emphasis added).

CTAs hate inflection points but love regime shifts,” explained Beer. “Mid-March was an inflection point: does this reflect a new regime and, if so, shouldn’t there be great money-making opportunities like during the GFC?”... CTAs historically have performed better in months 2-6 of a crisis . This could be week three of a global banking catastrophe,” Beer hypothesized." - ETFtrends

Trend-following managed futures funds generally use a two-month look-back period to spot trends, so naturally, when the world changes overnight, they can be caught offside.

• the banking crisis resulted in the strongest bond market rally in 42 years
• an eight-standard deviation event.

Why Managed Futures Are Still Worth Owning

Let's remember that if everything you own is going up at the same time, it means you're not as diversified as you think.

• If everything can go up together, then it can also go down together.

Managed Futures Net Of 5% Average Annual Fees Since 2000

Remember that managed futures can and do suffer bear markets, including 15% to 20% peak declines.

This Is Why We Own Managed Futures... To Provide Crisis/Bear Market Alpha

Every bear market is going to be different in terms of what's the optimal mix of assets to own.

The goal of the smart long-term investor isn't to guess the perfect mix but to own the right blue-chip assets that are most likely to get you to your goals while letting you sleep well at night no matter what happens.

(Source: Charlie Bilello, Barclays, Soc Gen, KraneShares.)

What About The 1970s Stagflation Hell?

Are you worried inflation isn't dead yet and might come back with a vengeance?

You should be, because that's what several economists such as Macrobond, UBS, and Soc Gen think might happen.

• Fed cuts too early
• inflation accelerated from a higher low and hits new higher highs
• Fed ends up going full Volcker and nuking the economy in 2028.

Managed futures are the best historical hedge against inflation.

During the 1970s, managed futures delivered 630% returns or 22% annually.

They doubled during the 1979 Iranian revolution and tripled during the 1973 OPEC oil embargo.

Since 1980 there hasn't been a single bear market where bonds + managed futures weren't flat or went up, and in the 1970s, the strategy also worked well.

• Bonds + managed futures = the best hedging strategy for the last 53 years
• including three 50+% market crashes.

Trend Following Managed Futures: 140 Years Of Solid Results

AQR is the largest managed futures operator in the world, and they've crunched the numbers for a strategy that has existed for 150 years.

• When futures were invented.

There is no better strategy if you want superior returns to bonds (4% historically) with no correlation to stocks or bonds.

Over the long term, trend-following managed futures generate positive returns in most markets, whether stocks are down or up. They generate positive returns as long as there is a trend to follow.

See all those negative return dots? Those are inflection points like what we're in now. Do inflection points mean that it's not worth owning managed futures as a percent part of your long-term portfolio?

Managed futures are there for crisis alpha, when stocks and sometimes bonds and stocks, both fall at the same time.

• like 2022.

Since 1880 a 20% allocation to managed futures would have resulted in:

• 171% higher inflation-adjusted returns than a 60/40
• 2% lower annual volatility
• 42% better volatility-adjusted returns.

In the Great Depression, U.S. stocks fell 86% and a 60/40 fell 62%. A 60% stock, 20% bond, and 20% managed futures portfolio fell 50%.

Do you know the difference between a 50% and 62% decline? It's not 12%.

• It's a further 24% decline.

In other words, during the worst stock market crash in U.S. history, owning 20% managed futures in a balanced portfolio would have prevented another bear market.

No strategy will work all the time, and between 1880 and 2013, managed futures suffered four bear markets.

Peak Declines For AlphaSimplex Managed Futures Since 2014

AlphaSimplex is a 5-star Morningstar-rated managed futures fund that's in the top 20% of its peers. And it suffered a 26% bear market that lasted six years from 2015 to 2021.

PIMCO also runs a five-star rated fund whose longest bear market lasted five years.

Does a long bear market prove a strategy is useless?

S&P Flat For 12 Years... So Investing In US Stocks Is Stupid?

The Dow Was Flat For 13 Years... So US Stock Investing Is A Bad Idea?

Nasdaq Was Flat For 15 Years... So Growth Investing Is Useless?

For the last 37 years, the Nasdaq is the best-performing index, with 13.5% annual returns. But it fell 81% along the way and was flat for 15 years.

What Can You Expect From Managed Futures In The Rest Of 2023?

A lot of people have been shocked at how horribly managed futures have performed in the last month, and that's understandable.

Unless you remember that managed futures are supposed to be uncorrelated to both stocks and bonds, that's why we own them.

They are supposed to zig when our other assets zag. And that's exactly what's been happening.

Remember, this new trend is one month old, and it usually takes two months for managed futures to adapt to a new trend.

Let's take a look at what DBMF, KMLM, and RSBT own today.

DBMF Holdings: 2-Month Lookback With Weekly Rebalancing

DBMF tracks the Soc Gen CTA index, which consists of the 20 largest managed futures funds. It's still short bonds, and the 2-year Treasury bond since the Fed has signaled that it's not done hiking yet.

• Fed says it plans to hike one more time in May.

DBMF is also short the S&P, which didn't help it much when the market is up 7% in Q1.

• But which will help should the market dive 15% to 30% in the coming months as history/economic data says it should.

KMLM Holdings: 2 Month Look Back, Daily Rebalancing

KMLM is more diversified and tracks an index that historically offers 2X the returns of other managed futures indexes.

But those 9.4% annual returns, double that of bonds and its peers, from 1988 to 2022, required riding out a 28% bear market from 2016 to 2019.

Today, KMLM is better positioned for the next few months.

• not as short bonds as DBMF
• Better positioned for the weaker dollar trend we're currently in.

RSBT Holdings: 2 Month Look Back, Daily Rebalancing, Fastest To Catch New Trends (In Theory)

(Source: RSBT.)

RSBT tracks the Soc Gen trend-following index, which consists of the 10 largest trend-following managed futures funds.

It then adds on 50% bonds and 50% T-bills, and right now, it's the best positioned for a bond rally that will likely continue until September or October.

What's Likely Coming Soon: Debt Ceiling/Recession Correction

The debt ceiling showdown is coming soon.

• Treasury says by June 5th
• Moody's by July 15th
• Congressional Budget Office September 9th.

Goldman and S&P expect it to be similar to the 2011 crisis, where the U.S. came within two days of defaulting.

• Congress is blustering right now with no progress in negotiations.

2011 Debt Ceiling Crisis: 22% Peak Intra-Day Decline In The S&P

The X-date in 2011's debt ceiling crisis was October 5th, and stocks peaked three months before that but didn't start falling until two months before the potential financial crisis that would have caused.

The last two weeks were the scariest back in 2011, and falling rates didn't help tech stocks one bit.

• Don't expect the Nasdaq to go up just because interest rates are crashing.

Most likely, by the time we hit the debt ceiling crisis of 2023, managed futures will be neutral to slightly long bonds and thus do what they did in 2011.

• flat in a crashing market.

What If Congress Raises The Debt Ceiling Soon And Averts The Crisis?

I have zero confidence that Congress will proactively reach a deal without the stock market selling off hard first. Why? Because the Freedom Caucus in the House is adamant that not a single penny in taxes be raised.

Here is what it would take to balance the budget without any tax increases.

GOP Speaker McCarthy has said that Social Security and Medicare won't be touched, neither will defense spending.

In other words, both sides in Congress are going to play a dangerous game of chicken as they prepare for the 2024 elections.

Congress postured in 2008 as well, sending the Dow down as much as 7% in a single day.

Market terror forced Congress to reverse itself the very next day.

• Rest assured rich people watching their portfolios collapse will get on the phone and slap sense into their representatives.

But I'm very confident that it will take a stock market correction to get Congress to raise the debt ceiling, given the current political situation.

But what if Congress surprises everyone and raises the debt ceiling next week? Months before the X-date?

Recession Is Still Coming Soon

• Recession Watch: A Mild Recession Is Likely Coming Soon .

The NY Fed's 12-month recession probability model estimates a higher risk of a recession within a year than before the tech crash, GFC, or at any time during the Pandemic.

The bond market thinks the recession will begin between July and September.

What does the actual economic data say?

The Baseline and Rate of Change or BaR economic grid is as close to a "God's eye" view of the economy as exists.

It includes 18 economic indicators, including nine leading indicators.

• It measures how far above or below each indicator's historical baseline and how fast they change every month.

The red dot is the average of all indicators, and the green dot is the average of leading indicators that tend to say where the red dot is going within three months.

The economic data says that a recession could begin within two to four months, around July.

• Just as the bond market is currently expecting.

The bond market is currently pricing in no more rate hikes and then steady cuts starting in July. No less than three Fed presidents have said not to expect any cuts this year, and BlackRock agrees, expecting the Fed to hold the line.

• a recession with no Fed cuts or bond buying
• the stock market is likely to freak out.

S&P Bear Market Bottom Scenarios

(Source: Dividend Kings S&P 500 Valuation Tool.)

The good news is that higher inflation tends to help prevent significant earnings declines in recession. The bad news? Even with no earnings growth in 2023 the market is NOT pricing in a recession right now.

Bank of America and Morgan Stanley's base-cases are that the bear market bottoms in September (perhaps coinciding with the debt ceiling crisis).

While October has a reputation for crashes, it is really a bear market killer. Of the past 17 bear (or near bear markets), stocks bottomed in October six times. " - Carson Wealth (emphasis added).

October is another potential bear market bottom, at least historically speaking.

The point is that we're likely in for a rough few months in stocks, and long-duration bonds are the best hedging strategy right now, according to:

• Morgan Stanley
• JPMorgan
• John Hancock Asset Management
• Charles Schwab
• TD
• Wells Fargo.

Bottom Line: I Trust These 3 High-Yield Managed Futures ETFs, And So Can You

Inflection points like we're in now for bonds can be a painful time for managed futures investors. But it's important to take a longer-term view.

The Power Of Diversification Since 2010

Managed futures, like bonds, are just one ingredient in your portfolio cake. Hedges are there to manage volatility and let you own stocks, which are what grow your income and wealth over time.

Stocks let us eat well, bonds and managed futures let us sleep well" - Wall Street axiom.

The Importance Of Diversification From 2015 To 2021 (Managed Futures Bear Market)

Even during the darkest days for any asset class, diversification still works. From 2015 to 2021, managed futures were flat because there were no consistent trends they were able to ride.

Yet investors who used the ZEUS asset allocation strategy of 67% stocks and 33% bond sand managed futures still earned solid returns and with low volatility.

In fact, their negative volatility-adjusted (Sortino ratio) returns were slightly better than a pure S&P 500 strategy.

Why not just own 100% stocks? Why bother with hedges at all?

The best way to measure your investing success is not by whether you're beating the market but by whether you've put in place a financial plan and a behavioral discipline that are likely to get you where you want to go.” Benjamin Graham.

Why don't pension funds own 100% stocks? Why don't endowments? Or sovereign wealth funds?

Because volatility matters to most people and financial institutions.

And becoming a forced seller for emotional or financial reasons is the #1 reason that the average investor badly underperforms the market and even a 60/40 or 40/60 portfolio.

Managed futures and bonds are historically the best way to build the ultimate sleep-well-at-night portfolio.

• 18 World-Beater Blue Chips For The Ultimate High-Yield Retirement Portfolio .

Just like the Nasdaq being flat for 15 years or the S&P for 13 years doesn't prove growth stocks or US stocks are stupid, the last month's poor managed futures returns mean nothing to long-term investors.

The goal of smart investing is not to try to jump 100% into the absolute best asset class of the moment but to buy the right mix of assets that will get you to your financial goals, no matter what happens in the coming years or decades.

My $2.2 million family hedge fund is 22% managed futures but overweight bonds because that's what's most likely to allow us to meet our goals, which is to rebalance into 1-3 years' worth of stock buying during the coming bear market.

In the coming weeks, I'll be presenting my exact strategy for prudently letting the bond market tell us when the stock bear market bottom is close and how to rebalance out of excess bonds into blue-chip bargains.

• Preparing for Recession Part 49: How To Sell Bonds To Buy Stocks During A Bear Market.

For further details see:

Three 9+% Yielding ETFs I Own, And So Should You