CTA: Diversified Strategy To Hedge For A Recession (NYSEARCA:CTA)

Investment Thesis

In an era of low interest rates and overvalued stocks, the CTA Simplify Managed Futures Strategy ETF (NYSEARCA:CTA) presents a compelling investment opportunity. This ETF seeks long-term capital appreciation through systematic futures investments and offers a return profile with a low correlation to equities. Its distinctive multi-strategy approach, which focuses on trend, carry, mean reversion, and risk-off strategies, makes it a valuable addition to any portfolio, particularly during volatile market conditions.

A Primer on Managed Futures Strategies

Due to their ability to generate profits in both rising and falling markets, managed futures strategies have acquired popularity among investors. These strategies involve investments in futures contracts across multiple asset classes, such as commodities, currencies, and fixed income. The objective is to profit from market trends, whether positive or negative, in order to achieve a level of portfolio diversification that is difficult to achieve with traditional asset classes.

CTA Simplify Managed Futures Strategy ETF: A Unique Approach

The CTA Simplify Managed Futures Strategy ETF stands out due to its systematic, one-of-a-kind approach to managed futures strategies. The ETF utilizes a set of systematic models created by Altis Partners, a commodity trading advisor with more than two decades of experience. This methodical strategy seeks to generate an absolute return profile that provides support in risk-off circumstances, making it a resilient option during market downturns.

This fund’s distinctive strategy, which excludes equity and currency indexes, is what sets it apart from other managed futures strategies. Instead, the fund invests in commodities and US and Canadian interest rates, ensuring a low correlation with equity markets. This approach is designed to consistently generate positive returns over time, regardless of market conditions at the time.

The strategy of the fund is based on four systematic models:

Price trend: This fundamental strategy anticipates market direction and invests accordingly, both long and short, relying on the persistence of price movement to generate returns.

Mean reversion: Designed to prevent the trend system from becoming overly positioned in a market perceived to be trading above or below its fundamental market value.

Carry: A strategy that attempts to “roll down” bond yield curves and exit positions prior to maturity in order to dependably capture the roll.

Risk-Off: A strategy that seeks to protect a portfolio from an equity drawdown by purchasing bonds rapidly in weaker equity markets and avoiding bonds in stronger equity markets.

These models work in tandem to generate a profile of absolute return with minimal correlation to equities, which provides support during risk-off events. This approach, along with the fund’s emphasis on low correlation with equities and adverse risk management during risk-off events, enables the fund to serve as a potent diversifier within equity-heavy portfolios. This distinctive strategy distinguishes the CTA Simplify Managed Futures Strategy ETF from its rivals and highlights its potential for long-term capital appreciation.

A Closer Look at the Performance

The CTA Simplify Managed Futures Strategy ETF has demonstrated promising performance over the past year. It has attained an annualized return of 3.61% as of March 31, 2023. Comparatively, the SG CTA Index, which represents a collection of CTAs, had an annualized return of 0.96% during the same time frame. This comparison demonstrates the ETF’s potential for long-term capital appreciation and emphasizes the benefits of including it in a portfolio.

While this may seem modest compared to average rates on savings accounts, it’s important to analyze the fund’s performance in the context of its peers. Between March 7, 2022 (at the inception date of CTA) and December 31, 2022, a period marked by significant market volatility in which both bonds and equities performed terribly, the CTA Simplify Managed Futures Strategy ETF delivered a positive return of nearly 15%. The S&P 500 delivered a negative return of nearly 14% during the same period.

The fund’s ability to navigate through these challenging market conditions and still generate positive returns underscores its resilience and strategic value. Its unique multi-strategy approach, focusing on trend, carry, mean reversion, and risk-off strategies, allows it to adapt and change based on market conditions, providing robust returns and stellar volatility management.

We acknowledge that current rates on savings accounts are attractive and could move higher in the very near term because the Federal Reserve hints at two more rate hikes in the second half of this year. Having said that, we think it will be challenging for the Fed to resume rate hikes because the reasons that justified a pause in June may still be valid in July and in the following meetings. Additionally, the release of a negative employment report would significantly intensify the pressure on the Federal Reserve to prolong its rate hike pause. In fact, the market expects only one rate hike by year’s end, according to the CME FedWatch Tool.

A Recession May Be Looming

While the US economy may presently appear robust, it is important to consider the underlying dynamics that suggest a recession may be imminent later this year.

In light of the financial turmoil in the regional banking system, the contraction in M2, a measure of money supply that includes cash, checking deposits, savings deposits, and certain other types of liquid assets held by households and businesses, is a cause for concern.

In addition, the US Treasury yield curve has been inverted for an extended and significant period of time, which historically has been a reliable indicator of an impending recession.

In addition to the Federal Reserve’s quantitative tightening, the rest of the world’s tightening monetary policy is also cause for concern.

In light of this, we believe that a recession in the US may occur as soon as the second half of 2023, which could elicit another bout of volatility in the market and push interest rates down. If our assessment proves accurate, the CTA Simplify Managed Futures Strategy ETF could demonstrate its value during a potential recession, providing a means to navigate market volatility and potential interest rate declines.

Four of the seven indicators used by the National Bureau of Economic Research (NBER) to determine whether the United States is in a recession (industrial production, average of GDP and GDI, real personal income excluding fiscal transfers, and real manufacturing) have stagnated or are already consistent with a recession over the past year. Employment and real consumption, however, continue to expand.

While current market sentiment may prompt some investors to believe that the US economy will avoid a recession, we stress the importance of distinguishing between macroeconomic sentiment and the underlying health of an economy.

Holdings Review

According to the most recent portfolio update, the Fund is long live cattle (23%), the Canadian 10-Year Government Bond Futures (5.7%), copper (3.6%), and net short short-term treasury rates futures, particularly the 5-year US Treasury Note futures contract (-65.4%), as well as cotton (-13.3%), gold (-9.4%), and wheat (-8.2%). The Fund reserves the right to alter its positions at any time.

Costs

There are costs associated with investing in the CTA Simplify Managed Futures Strategy ETF that investors should be aware of. The Annual Fund Operating expenses paid by investors as a percentage of the value of their investment are 0.75 percent annually. In addition, investors purchasing or selling shares of the Fund on the secondary market may incur costs (such as standard commissions levied by their broker).

Risks

The CTA Simplify Managed Futures Strategy ETF entails risk, as do all investments. These include the risks endemic to futures contracts, such as leverage risk and mispricing or improper valuation risk. Before investing, investors should thoroughly consider these risks. Despite these dangers, the potential for absolute returns and portfolio diversification render this ETF an attractive investment opportunity.

The Management Team and Strategy

As with all investments, the CTA Simplify Managed Futures Strategy ETF is subject to risk. Here are the primary risks to our buy recommendation for the Fund.

Interest rate volatility: Interest rate volatility can undermine the performance of trend-following strategies, as it was the case during the recent regional bank crisis.

Trend absence: The Fund’s performance is heavily dependent on the success of its trend-following strategies. In the absence of trends in the market, these strategies could struggle.

Risk Management: Important is the fund’s ability to effectively manage risk during periods of elevated volatility. If the fund is incapable of adapting to rapidly altering market conditions, significant losses may result.

These risks highlight the significance of evaluating a potential investment in light of the dynamic nature of financial markets, the fund’s strategic approach, and its risk management capabilities. Despite these risks, the fund’s distinctive strategy and potential for long-term capital appreciation may make it an attractive investment opportunity.

Conclusion: The Strategic Value of the CTA Simplify Managed Futures Strategy ETF

The CTA Simplify Managed Futures Strategy ETF provides a novel approach to portfolio diversification and capital appreciation over the long term. The fund’s distinctive multi-strategy approach, which emphasizes trend, carry, mean reversion, and risk-off strategies, distinguishes it from its rivals. This strategy, coupled with its emphasis on commodity and financial futures, has enabled it to outperform its competitors and the market as a whole, making it an attractive investment opportunity.