Making the Move to Managed Futures: Factors to Consider
By Bruce Tursman
FEB 2007
If you are exploring an investment in futures for the first time, you might not know all the alternatives available to you. Perhaps you've considered trading yourself, but have decided you'd rather let a professional money manger take the reins—and make the day-to-day decisions for you. You are probably familiar with the way mutual funds operate, but may not realize there is also a way you can invest in commodity futures markets through a passive, hands-off approach—via a managed futures account. Like choosing a mutual fund, you have many choices to make when selecting the right managed futures program for you. Choosing the right commodity trading advisor (CTA), the professional who will be running it, is equally important. Lind-Waldock can help.
What are Managed Futures?
Managed futures represent an industry comprised of professional money managers who manage client assets on a discretionary basis, using global futures and options markets as an investment medium. Often the term managed futures is considered a subset of the hedge fund industry, although managed futures operate exclusively in the futures markets, not cash equity markets. The manager makes all decisions on the clients' behalf through a revocable power of attorney. These managers use a variety of trading approaches; some rely exclusively on technical analysis to make their decisions, others, fundamental information, and others, a variety of both. These managers, called CTAs, are registered with the National Futures Association.
Growing numbers of corporate, institutional and individual investors have been allocating a portion of their portfolio's assets to managed futures accounts.
According to Barclay's Research Group LTD, money under management during the fourth quarter of 2006 was $170 billion. This figure represents a 30.17 percent increase in assets over the past year.
Each CTA employs its own unique strategy and trades a unique combination of markets. Lind-Waldock's Managed Futures Division can help you understand the difference among the various trading advisors.
Why Managed Futures?
Many investors find managed futures can reduce volatility in their overall investment portfolio. Research has shown that there's a relatively low correlation between the performance of managed futures and stock prices or interest rates over time. Through a managed futures investment, you'll have access to futures markets around the globe. CTAs trade financial futures including stock indexes such as the Standard & Poor's 500 or the Nikkei 225, interest rate vehicles such as U.S. Treasury notes or the German bund, or currencies such as the euro or yen. Traditional commodity markets traded include crude oil, gold, wheat or soybeans.
Unlike other asset classes, where profits depend solely on price appreciation, opportunities in commodity futures trading exist in both rising and falling markets. Strategies using options on futures contracts seek to provide profit potential in flat or neutral markets.
Making the Decision
However, managed futures are not appropriate for everyone. A determination must be made as to a particular investor's suitability, at which point you will be provided with all of the necessary information to make sure you understand both the risks and possible rewards of this type of investing. Generally, in addition to having the required risk capital, you need to have realistic expectations about potential returns on investment, and tolerance to losing periods, or drawdowns, that inevitably will occur with managed futures products.
Lind-Waldock's Managed Futures Division offers a Web page that provides a good overall view of managed futures, including a CTA Rankings Site which provides a database of more than 100 CTAs you can choose from. It includes information such as performance, margin use and risk management.
As you look at an individual CTA's statistics, you want to first make a determination of the risk tolerance you can accept. Observe the maximum drawdown amount associated with the CTA, and check the return/maximum drawdown average. You may also get an idea of the CTA's use of money management from the amount of average margin used.
Next in importance to consider would be the monthly performance report. You can view the monthly percentage gains and losses for the CTA, the totals for the year, and the amount of money under his or her management.
Looking Beyond Performance
There are many important factors to consider when investing in a CTA program that can go beyond just looking at the returns in any given month or year. For example, a CTA with an annualized rate of return of 30 percent might look better to you on the surface than one with a 10 percent return. However, this may be deceiving if they have radically different dispersion of losses—that is, one advisor may have more volatility in terms of returns throughout the year, while another sees a more steady rate of return. The CTA with a 30 percent gain may have average drawdowns of 30 percent, while the CTA with 10 percent annual returns may average drawdowns of only 2 percent.
Another aspect to look at is the Sharpe ratio. This number is in essence, a measure of risk-to-reward efficiency of an investment. This number can help you determine if the returns are due to smart investment decisions—or a result of excess risk. The greater the Sharpe ratio, generally the better the risk-adjusted performance.
What About Management Fees?
Typically, the trading advisor or trading manager is compensated by receiving a small 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 each quarter if the account reaches a new high-water mark. So, while you might initially balk at fees, if the manager is earning large returns, his or her sevices may be worth paying a premium.
These are just a few factors to consider when choosing a managed futures program. We'd be happy to work with you on an individual basis to help you determine if this type of investment is right for you.
Please feel free to browse Lind-Waldock's CTA Rankings Site and take a look at the factors discussed here. And feel free to call us at 800-452-1030 with any questions you have.
Bruce Tursman is Account Executive, Managed Futures Division of Lind-Waldock. He can be reached at 312-788-2988.
Kristina Zurla Landgraf is editor of Lind eWire. She can be reached by email at editor@lind-waldock.com.
Futures trading involves substantial risk of loss and is not suitable for all investors.Past performance is not necessarily indicative of future trading results. Trading advice is based on information taken from trade and statistical services and other sources which Lind-Waldock believes are reliable. We do not guarantee that such information is accurate or complete and it should not be relied upon as such. Trading advice reflects our good faith judgment at a specific time and is subject to change without notice. There is no guarantee that the advice we give will result in profitable trades. All trading decisions will be made by the account holder.
© 2007 Lind-Waldock, a division of MF Global, Ltd. All Rights Reserved.
