Managed Futures programs are a type of alternative investment that provides everyday investors the opportunity to invest in the futures and options markets.
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The advantages of investing in managed futures within a well-balanced portfolio include reduced volatility, the ability to profit regardless of market direction, and global portfolio opportunities.
Managed futures as an asset class is increasingly being recognized as an important investment alternative that can potentially enhance the returns and lower the overall volatility of a portfolio.
Although futures investments involve substantial risk and are not suitable for everyone, the introduction of managed futures to an investment portfolio can both reduce risk and enhance performance.
Managed Futures are an alternative asset class that has achieved strong performance in both up and down markets, exhibiting low correlation to traditional asset classes, such as stocks, bonds, cash and real estate
Pension Plan Sponsors, Endowments and Foundations have long used Managed Futures to generate returns in excess of the S&P 500
What Are Managed Futures?
The futures and options markets are based on futures and options contracts—legal agreements between buyers and sellers of commodities (including energy, metal and agricultural products) and financial instruments (foreign currency, government bonds and equity indexes, for example) for a future sale (or option for sale) of assets. Investors in managed futures do not necessarily agree to purchase or sell these commodities or currencies, but instead invest in the contracts themselves.
Managed futures investments are managed by professional investment individuals or management companies known as Commodity Trading Advisors (CTA). CTAs speculate on the price fluctuations of the various futures and options markets. CTAs are registered with and regulated and monitored by both the U.S. Commodity Futures Trading Commission (CFTC) and the National Futures Association (NFA). As CTAs employ distinct investment methods, clients must decide which CTA will provide the best addition to their existing investment portfolio based on the firm’s performance and risk strategy.
Unlike the stock market, which offers investors partial ownership in a company and a proportional share of its gains and losses, an investment in managed futures yields returns (or losses) based on the investment performance of a CTA. Furthermore, while a managed futures investment involves exchange-traded futures markets, the investment itself is not traded on exchange.
Another distinguishing characteristic of a managed futures program is that it is not a pooled investment vehicle like a mutual fund, which utilizes capital from a group of investors, although many mutual funds involve investments in the futures and options markets. Instead, a managed futures investment operates under a separately managed account (SMA) structure; each client’s portfolio is managed on an individual basis as a single account, allowing for increased liquidity and transparency.
Why Managed Futures?
For more than 30 years, investment management professionals like CTAs have helped investors expand their portfolios with investments in managed futures. As investors increasingly seek alternatives to such traditional assets as stocks, bonds and real estate, investment in the managed futures industry is experiencing significant and steady growth. The industry saw an approximately six-fold rise in invested assets, for example, just between 2000 and 2010, during which time investments increased from about $40 billion to nearly $250 billion.
Yet this rapid investment growth is fueled by only a small percentage of investors, those who have been properly educated on the available types of investment vehicles, including alternative investments such as managed futures. Why don’t more people invest in this growing industry? Many investors are simply unaware of the opportunity managed futures programs present, while others believe they lack the capital necessary for investment. (Although managed futures programs require substantial investment, minimum investment amounts are not as high as many investors think.)
The industry continues to grow as more investors learn about the benefits of including managed futures in a well-balanced portfolio.
Benefits of Managed Futures
Broad Diversification Opportunities
Offering highly diverse investment opportunities—in terms of both geography and product—managed futures are a natural choice for investment portfolio diversification. Through managed futures programs, CTAs provide investors flexible investment options that are traded on over 150 global financial and commodity markets. Managed futures investment portfolios may include agricultural commodities, energy products, metals, interest rates, equities and foreign and domestic currencies.
Reduced Overall Portfolio Risk
Because of this inherent diversity, managed futures offer the potential for lower overall volatility in a balanced investment portfolio. Moreover, investment in diverse global futures markets complements a portfolio’s other traditional asset classes, with which managed futures have virtually no long-term correlation; managed futures have the ability to yield profits regardless of the movement of stocks and other investment vehicles. It is important to note, however, that no managed futures program is without risk and any investment may be subject to substantial loss.
Enhanced Overall Portfolio Returns
Managed futures programs’ diversity and potential for reduced investment volatility contributes to their capacity to boost overall portfolio gains. A diverse, well-balanced investment portfolio can offer more effective performance. Adding managed futures to a portfolio of traditional investments provides the potential for higher returns with lower risk. Since each unique program is based on a particular CTA’s investment strategy and past performance is not indicative of future results, therefore, managed futures offer no guarantee of profit.
Profit Potential During All Economic Environments
Managed futures investments can generate profit in almost all market conditions. Managed futures give investors the ability to go long—buy futures positions—in order to profit from rising markets, go short (by selling positions) in anticipation of falling prices or take a more conservative approach with a spread that combines long and short positions. Managed futures have historically performed well in market conditions that are adverse for traditional asset classes like stocks and bonds. But as past performance is not indicative of future results, managed futures investments may not necessarily follow this trend.
An investor’s profits earned from managed futures accounts are taxed as if they are comprised of 60 percent long-term capital gains and 40 percent short-term capital gains. This is significant, because long-term capital gains are subject to a maximum federal income tax of just 15 percent, while short-term capital gains may be taxed at a rate as high as 35 percent. Many other investments, including stocks, must be held for at least 12 months before being taxed at the long-term capital gains rate. Managed futures accounts, though, do not require a specific length of investment to qualify for the coveted long-term capital gains tax rate.
Managed futures programs involve investment in highly regulated global markets. All U.S.-based futures investments are regulated by the CFTC and the NFA. With few exceptions, all CTAs and other professionals and firms conducting business on the futures market must register with both the CFTC and the NFA. The CFTC has the power to bring criminal charges against those who engage in fraudulent conduct or abusive practices and the NFA, in addition to its monitoring function, develops rules, programs and services that help safeguard market integrity.
Transparency and Liquidity
This tight regulation results in maximum transparency for investors. CTAs must provide all clients with daily access to account statements, details of all positions and complete disclosure information. And because managed futures accounts are settled on a daily basis, investors have the ability to monitor and track daily account activities. Since managed futures accounts are credited and debited daily, investments are generally highly liquid; investors maintain tight control of accounts and may withdraw or transfer funds as necessary to further reduce risk.
How Does Investing in Managed Futures Work?
Managed futures may seem somewhat confusing to new investors. To better understand what managed futures programs are, it is helpful to consider what they are not: managed futures investments are not the equivalent of stocks of commodity-driven companies, nor are they trend-driven mutual funds or exchange-traded funds (ETF).
Instead, managed futures offer investors the opportunity to invest in the global futures markets through a CTA, a professional who manages client assets based on agreed-upon investment strategies and conducts trading on their behalf. CTAs develop unique investment approaches that take a variety of forms, ranging from trend-following strategies that aim to profit from market changes to market-neutral approaches that rely on more conservative methods, as well as a diverse set of combination methods.
Managed futures funding requirements are as diverse as CTA strategies and the global futures markets on which they trade. Most CTAs require a minimum investment level, which typically falls between $25,000 and $5,000,000. Some CTAs further require a minimum net worth or income level. These amounts are based on a CTA’s level of experience, target investment audience, trading strategy and past performance.
Many CTAs offer clients the option of notional funding, which allows investors to leverage their managed futures accounts. Because the notionally funded amount is not borrowed or deposited, but instead acts as a good faith deposit for the full value of the account, this leverage does not incur additional cost. While notional funding is attractive to many investors, others are cautious of its increased volatility; with notational funding, all gains and losses are multiplied proportional to the level of funding provided.
A $100,000 account that is notionally funded at 50 percent, for example, requires an investment of $50,000. The account would be traded as if it were fully funded at the $100,000 level. If the account sees a 10 percent return, the investor thus receives a $10,000 profit, equal to 20 percent of the actual funding provided. If, however, the account experiences a loss of 10 percent, the account is debited $10,000, amounting to a 20 percent loss of funds.
Understanding the Fee Structure
There are two major fees associated with managed futures investments. The first fee, the management fee, provides compensation for a CTA’s investment management services. This annual fee is generally deducted from investor accounts on a prorated, monthly basis. The amount of the fee typically ranges from 0 to 2 percent and is based on the specific investment program and the CTA’s experience level.
Some CTAs waive the management fee in favor of the second major fee associated with managed futures accounts: the performance, or incentive, fee. While certain CTAs do not charge a management fee, all accounts are subject to an incentive fee. This fee usually falls between 20 and 30 percent of investment profits. The incentive fee provides the CTA with the motivation—or incentive—to maximize performance; as the investor profits, so does the CTA. The incentive fee acts as a CTA’s main source of income.
Many CTAs apply a high watermark to investor accounts. With the condition of a high watermark, a manager receives an incentive fee only on the amount of money that exceeds the account’s prior highest value. Should the investment drop in value, the CTA does not receive an incentive fee until the account is restored to a level above that watermark. Under this fee structure, CTAs receive incentive fees only on net new profits.
Disclosure Documents and Background Research
A CTA’s disclosure document fully explains the process of investing in a managed futures account. The disclosure document, or D-Doc, as it is commonly called, outlines important information about managed futures investments in general and with respect to the CTA’s specific program. The D-Doc describes all potential risk factors and required fees associated with investment. The document also provides information about the CTA, including background information, trading methodologies and performance history. Performance metrics included in disclosure documents are standardized, allowing investors to accurately compare CTAs.
Careful study of a CTA’s disclosure document is a critical part of the investment decision-making process. Potential investors should request a CTA’s D-Doc before making any investment decisions and should fully understand the document before signing the included agreement that authorizes the CTA to direct trading in their accounts. CTAs must update disclosure documents at least every nine months, but investors can request more recent performance information if necessary. The CFTC and the NFA (including its Background Affiliation Status Information Center—or BASIC—database) provide investors with further information about individual CTAs.