What are managed Futures?

The term managed futures describes an industry made up of professional money managers known as commodity trading advisors (CTAs). These trading advisors manage client assets on a discretionary basis using global futures markets as an investment medium. Trading advisors take positions based on expected profit potential.

Investment management professionals have been using managed futures for more than 30 years. More recently, institutional investors such as corporate and public pension funds, endowments and trusts, and banks have made managed futures part of a well diversified portfolio. In 2004, it was estimated that over $130 billion was under management by trading advisors.

The growing use of managed futures by these investors may be due to increased institutional use of the futures markets. Portfolio managers have become more familiar with futures contracts. Additionally, investors want greater diversity in their portfolios. They seek to increase portfolio exposure to international investments and non-financial sectors, an objective that is easily accomplished through the use of global futures markets.

Types of Investment Opportunities

According to the Barclay Trading Group, Ltd. in 2004, it was estimated that over $130 billion was under management by futures trading advisors worldwide. Currently, there are three primary categories of managed futures.

Individual Accounts are usually opened by institutional investors or high net worth individuals. These funds usually require a substantial capital investment so that the advisor can diversify trading among a variety of market positions. An individual account enables institutional investors to customize accounts to their specifications. For example, certain markets may be emphasized or excluded. Contract terms may include specific termination language and financial management requirements.

Private Pools commingle money from several investors, usually into a limited partnership. Most of these pools have minimum investments ranging from approximately $25,000 to $250,000. These futures partnerships usually allow for admission redemption on a monthly or quarterly basis. The main advantage of private pools is the economy of scale that can be achieved for mid sized investors. A pool also may be structured with multiple trading advisors with different trading approaches, providing the investor with maximum diversification. Because of lower administrative and marketing costs, private pools have historically performed better than public funds.

Public Funds or Pools provide a way for small investors to participate in an investment vehicle usually reserved for large investors.

Evaluating Risk

Participants in the Managed Futures Industry

There are several types of industry participants qualified to assist interested investors. Keep in mind that any of these participants may, and often do, act in more than one capacity.

Commodity Trading Advisors (CTAs) are responsible for the actual trading of managed accounts. There are approximately 800 CTAs registered with the National Futures Association (NFA), which is the self regulatory organization for futures and options markets. The two major types of advisors are technical traders and fundamental traders. Technical traders may use computer software programs to follow pricing trends and perform quantitative analysis. Fundamental traders forecast prices by analysis of supply and demand factors and other market information. Either trading style can be successful, and many advisors incorporate elements of both approaches.

Futures Commission Merchants (FCMs) are the brokerage firms that execute, clear, and carry CTA directed trades on the various exchanges. Many of these firms also act as CPOs and trading managers, providing administrative reports on investment performance. Additionally, they may offer customers managed futures funds to help diversify their portfolios.

Commodity Pool Operators (CPOs) assemble public funds or private pools. In the United States, these are usually in the form of limited partnerships. There are approximately 1,500 CPOs registered with the NFA. Most commodity pool operators hire independent CTAs to make the daily trading decisions. The CPO may distribute the product directly or act as a wholesaler to the brokerdealer community.

Investment Consultants can be a valuable institutional investor resource for learning about managed futures alternatives and in helping to implement the managed fund program. They can assist in selecting the type of fund program and management team that would be best suited for the specific needs of the institution. Some consultants also monitor day to day trading operations (e.g., margins and daily market to market positions) on behalf of their institutional clients.

Trading Managers are available to assist institutional investors in selecting CTAs. These managers have developed sophisticated methods of analyzing CTA performance records so that they can recommend and structure a portfolio of trading advisors whose historic performance records have a low correlation with each other. These trading managers may develop and market their own proprietary products or they may administer funds raised by other entities, such as brokerage firms.

How the Fee Structure for Managed Futures Works

Total management fees in the managed futures industry tend to be higher than those in the equities market. These fees, however, may be partially offset by the lower commission costs for comparable dollar transactions in the futures industry. While management fees do vary by the type of managed futures account and may be negotiable, there is a general fee structure. Investors should understand that performance information for a managed futures account or fund is almost always expressed net of all such fees.

Typically, the trading advisor or trading manager is compensated by receiving a flat management fee based on assets under management in addition to a performance "incentive" fee based on profits in the account. The performance fee is almost always calculated net of all costs to the account, such as management fees and commissions. The performance fee is thus based on net trading profits, which are usually paid only if the account or fund exceeds previously established net asset values.

A few trading managers assume the "netting risk," whereby the performance results of all trading advisors in the account are netted before the investor is charged a performance fee. The trading manager assumes the netting risk by paying each CTA according to his or her individual performance.

In addition to management and performance fees, an account or fund pays transaction costs or brokerage commissions. These expenses reflect the cost of executing and clearing futures and generally are calculated on a per round turn basis.

Investor Safety Is Paramount in the Futures Market

Protecting the interests of all participants in the futures market is the responsibility of exchange and industry members as well as federal regulators. Working together, they ensure the financial and market integrity required by investors.