» What are managed futures?
Managed futures are the systematic or discretionary trading of futures contracts by professional Commodity Trading Advisors (CTAs) who trade in global futures and options markets, as either buyers or sellers of contracts representing real assets such as gold, silver, wheat, corn, coffee, sugar and heating oil, as well as financial assets such as government bonds, equity market indices and currencies. The CTA makes all trading decisions on behalf of the client through a revocable power of attorney.
» What is a CTA?
A CTA is a Commodity Trading Advisor. A CTA is an individual or organization which, for compensation or profit, advises others as to the value of or the advisability of buying or selling futures contracts or commodity options. Providing advice indirectly includes exercising trading authority over a customer´s account, as well as giving advice through written publications or other media. For further information on Commodity Trading Advisor please refer to the National Futures Association and the Commodity Futures Trading Commission.
» How do managed futures compare to stocks and bonds?
Generally speaking, because managed futures have little correlation to stock and bond markets, it is quite difficult to make a comparison. It may be common practice for investors to dissect the individual elements of their portfolio and expect them to compete with one another over every time period. However, effective and prudent asset allocation would suggest that: Managed futures cannot be looked at in isolation from the rest of the portfolio, nor should they be examined in relation to the stock market. It is very important to ensure investors have a balanced approach to investing, to understand the rationale behind allocating portions of assets to different investment classes, styles or instruments, and that they always keep their long–term goals in mind. Different instruments within their portfolio should complement each other, not compete with each other. It is important to remember that different investments derive profitability from a variety of economic and market scenarios, and that investments will not all perform at the same time. Otherwise, all investments would make money together and all would lose money together.
» How are managed futures used in an investment portfolio?
With prudent allocation, managed futures may help reduce the overall risk of a portfolio. A prudent investor should ensure that at least a portion of their portfolio is allocated to an alternative asset class that has the potential to perform well when other portions of the portfolio may be underperforming.
- Other potential benefits of managed futures may include:
- Historically competitive returns over the longer term
- Returns independent of traditional stock and bond markets
- Access to global markets
- The unique implementation of traditional and non–traditional trading styles
- Potential exposure to as many as one hundred and fifty markets globally
- Liquidity and no lock–ups. The contracts in which the CTAs trade typically have a high degree of liquidity. If suitable to a client´s objectives, devoting five to fifteen percent of a typical portfolio to alternative investments has been shown to increase returns and lower volatility. Because alternative investments may not react in the same way as stocks and bonds to market conditions, they may be used to diversify investments over different asset classes, resulting in less volatility and less risk.
» How can diversification through using managed futures help reduce risk?
During times of market volatility or declining stock and bond markets, managed futures may be an important part of your portfolio. In the event of a major, sustained downturn of the equity or fixed income markets, managed futures may potentially provide some protection for a client´s overall portfolio. Increasingly sophisticated institutional investors such as pension funds, endowments, foundations, and family offices are allocating larger portions of their portfolios away from equity and fixed income into alternative investments. Managed futures are a sub–class of alternative investments.
» Who regulates Commodity Trading Advisors?
Commodity Trading Advisors are regulated by the Commodity Futures Trading Commission (CFTC) and by the National Futures Association (NFA), the congressionally authorized self–regulatory organization of the futures industry. All trading advisors must be registered with the CFTC and those who manage customer accounts must be members of the NFA. Advisors´ Disclosure Documents are required to be submitted to the NFA for review in advance of distribution to prospective investors. On an ongoing basis, the NFA audits Disclosure Documents (particularly performance information), promotional materials, and trading activities. Many CTAs update their performance data on a monthly basis. Violations of CFTC or NFA rules can result in financial penalties, suspension or complete cessation of trading privileges and other penalties.
» What are the costs, and how do CTAs get paid?
There are basically three types of charges involved when a managed account is handled by a CTA. An annual management fee usually between 1–2 % of the value of your account is charged for the overseeing of the trading in your account. Normally this fee is charged in monthly, for example a 2% annual fee would result in a 0.1667% monthly charge being applied to the account. Most CTAs also charge a performance incentive fee which typically runs from 15– 25% of the cumulative net trading profits calculated at the end of each quarter. The net trading profits are the combined total of profits and losses from trading. Other costs associated with a managed futures account include FCM brokerage costs, exchange and regulatory association fees.
» How much money should I invest in managed futures and how do I open an account?
We recommend that the amount of money you invest be based on your own financial goals and risk tolerance. This should usually be approximately 5-20% of your overall portfolio. Only risk capital should be used in managed futures or any speculative investment. Before opening an account you must be supplied with a copy of the CTA´s Disclosure Document. Read it carefully and go over any questions you have with your broker before you invest. After your questions have been answered and you feel this type of investment is appropriate for you, we will assist you in completing the CTA management agreement and Customer Agreements and account opening forms.
» Are there any tax benefits to investing in managed futures?
According to the Tax Act of 1981, short–term profits (held for less than one year) in commodities are treated as 60% long term and 40% short term. On the other hand, short–term trading profits in stocks are treated as 100% short term. For individual investors in higher tax brackets, this tax treatment can mean saving as much as 30% on taxes on short–term gains on commodities versus stocks. We strongly recommends that you should discuss the taxation elements relating to your investment with an independent qualified tax advisor.
» Are managed futures suitable for all investors?
Managed futures are not appropriate for everyone. A determination must be made as to a particular investor´s suitability, the investor should be provided with all of the necessary information to make sure he or she understands both the risks and possible rewards of this type of investment. In addition to having the required risk capital, an investor needs to have realistic expectations about returns on investment and tolerance to drawdowns that may occur with managed futures products. The risk of loss always exists in futures trading no matter how skilled a trader an individual CTA may be.
» Why is the CTA’s Disclosure Document so important?
CTAs and CPOs (Commodity Pool operators) are required to file disclosure documents with the NFA. The basic disclosure requirements are intended to ensure that potential investors will be apprised of material facts regarding managed investments and advisors so that they can make an informed decision about a particular investment or advisory service before committing their funds. The CFTC in November 1997 delegated to the NFA the authority and responsibility to conduct the reviews of disclosure documents of both CTAs and CPOs required to be filed with the commission. Only upon satisfactory review of the disclosure documents and subsequent approval by the NFA can a CTA or CPO offer his disclosure document to the public for consideration. Disclosure documents provide biographical information on the CTA and generally reviews the trading style and account management philosophy of the CTA as it applies to that particular program. The Document will also contain a review of the trading program along with a list of all fees, potential conflict of interest issues, and a description of the CTA´s risk management methodology. Performance records are also reviewed showing the net trading results after costs have been deducted.
» What is the minimum investment needed to establish an account?
Each CTA has their own minimum account size and that can vary from as low as $25,000 to multiple millions. Generally speaking the newer CTAs have lower minimum entry requirements as they are still in asset building stage whereas older, more established CTAs tend to have higher minimum account requirements.
» Have there been any performance comparison studies between self-directed traders and CTAs?
There are some individual investors who are highly successful in directing their own futures trading if they have the knowledge, experience and resources to do so. However the vast majority of self-directed investors have struggled in their efforts to become successful in futures trading. Studies indicate that as many as nine out of ten self-directed traders lose money. When it comes to managed futures, of the 119 funds and pools in the Managed Account Reports Fund/Pool Qualified Universe Index that traded from January 1990 through October 1996, 81% were profitable over the full-time period. (Source —MAR)
» How does an investor interpret a track record in judging the performance of a CTA?
Investors should take particular note of the Trading Advisors Performance Record. However, this in itself should not be the sole reason for choosing a specific CTA. As mentioned above, the Disclosure Document spells out an advisors philosophy and trading style. This should be reviewed along with the track record in making your decision. Track records are important and should show performance tables, spanning several years or more. A strong performance over a short period of time may be nothing more than good fortune. However, positive performance over a long period of time especially in markets that have experienced bull bear and flat trading ranges speak volumes about a CTA´s trading abilities. Track record components to take careful note of:
- Length of the trading program … Good fortune or sustainable investing?
- Worst peak to valley drawdown … Could your account be profitable assuming worst entry?
- Assets under management … Has the manager significant assets under management?
This information was prepared by James O’Connell, Director Walsh Capital Management.
This FAQ section was compiled using various sources as well as the opinions of the author. The information presented herein is for informational purposes only and not to be relied upon as legal opinions. To get more information regarding these frequently asked questions please go to the National Futures Association.
- Managed Futures: Portfolio Diversification Opportunities*
- Frequently Asked Questions About Managed Futures*
- In Search of Crisis Alpha
- Managing Event Risk*
*In regards to these promotional materials from the CME Group, there are limitations associated with managed futures indices. In particular, an index does not represent the entire universe of all CTAs. Additionally, individuals cannot invest in an index itself and actual rates of return may be significantly different and more volatile than those of the index.