How to Beat Hedge Funds at Their Game, According to Baupost Alum

(Bloomberg) – This year’s bear market in stocks has drawn much attention to hedge funds, many of which have fared much better than the market as a whole. But what if you could package some popular hedge fund strategies into ETFs that charge a fraction of the management fees and don’t come with all the strings attached to who can invest in them and when they can withdraw? Andrew Beer has been working to do just that – successfully – with a fund he co-manages at Dynamic Beta.

Beer, a graduate of Seth Klarman’s Baupost Group, joined this week’s episode of the What Goes Up podcast to talk about what’s behind the success of his managed futures ETF.

Below are condensed and lightly edited highlights of the conversation. To listen to the full podcast, click here, or subscribe to Apple Podcasts or wherever you hear it.

Q: You co-manage the iM DBi Managed Futures Strategy ETF, which is up more than 20% so far in 2022. Talk to us about how the idea of ​​replicating hedge fund strategies came about.

A: With hedge funds, it’s always the big trades that make the difference. When Stan Druckenmiller mentions inflation, he’s not talking about trying to mediate between the 29-year and the 30-year Treasury. He says, “I bet bets are going up and commodities are going up.” When people talk about John Paulson and subprime, they don’t say, “Oh, but his very best deal was to buy a few million dollars of this tranche and off it to profit.” So it’s pretty obvious to anyone who has worked in the hedge fund industry that if you understand the big hedge fund trades, you will also be able to explain most of what they do do.

MIT’s Andrew Lo and a bunch of other academics basically pointed out what was pretty obvious to people in the industry all along in 70-page papers full of statistics. Hedge fund replication as a strategy is just trying to find the best way to identify those big trades and then copy them cheaply and efficiently today. And if you can do it, you can do it in an ETF. You can do it in a mutual fund, you can do it in a UCITS fund. I’ve been looking at this question for 15 years and there’s only one thing we found. If we could find something better, we would do it. This is the only one we’ve found that works reliably well.

Q: Can you tell us more about your iM DBi Managed Futures Strategy ETF?

A: In this ETF, we’re basically replicating the large positions of 20 major hedge funds that use a strategy called managed futures. Managed futures is one of those annoyingly vague and complicated terms that people use and don’t really understand. But fundamentally, these hedge funds have quantum-based strategies that take advantage of the fact that the rest of us human investors are kind of emotional — we don’t change our minds easily, we sometimes jump into things too late, and so on.

So that creates trends in the market. An asset that begins to roll down a hill, continues to roll, and sometimes accelerates. And they don’t always get it right, but sometimes they really do get it right. And this year they really got it right.

So basically we look at these 20 big hedge funds and we say, okay, if they buy crude oil, we’ll just go out there and buy a futures contract on crude oil. If they short Treasuries and bet rates will go up, we go out and short Treasuries. If you are betting that the dollar will be strong against the yen, we make the same trade. So the whole idea is that you have really smart people doing this with tons and tons of resources every day. We’re almost like Ikea – we’re just trying to copy what they do, but cheaply and efficiently.

Q: And what has the ETF done this year?

A: To everyone’s surprise, the biggest winner this year was actually a short position in the yen against the dollar. And again, when you’re talking about the craziest things in the market, I think if you asked FX strategists earlier this year, the yen is at 115, where could it possibly go? The guy who said 125 would have been laughed out of the room. Lo and behold, it almost reached 140. The funds got that position early and rode it. But also, they were long crude at the right time, they were short Treasuries when prices started to rise. So it was really three big core businesses that delivered most of that performance.

Q: I’m curious, can it be something that can be systematic and rules based, or is there a lot just watching the tape and making arbitrary decisions about what the trends are like?

A: I irritate a lot of people in the managed futures space by basically saying I don’t think it’s that complicated. To me, it’s the modern version of that guy we all know with a candlestick chart telling you that something just broke its moving average and is set to continue rising.

But what did the guy say? He said people fall in love with stocks and drive them higher. They jump out of things and throw things away at the same time. Sometimes the world changes and they react very, very slowly. What a managed futures fund does is lots of people sitting around with lots of computers. So it’s not like someone built a computer and then got it to work like Tesla Autopilot.

Rather, the guys are trying to figure out and constantly tweaking and changing the models, trying to figure out the right parameters over time. So it’s a systematic strategy that these guys have computers running what they buy and sell every day. But there’s a very human side to how people build the models, what they like and don’t like.

These were just the highlights of the conversation. Click here to listen to the entire podcast.

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