The first Managed Futures Fund may have actually been established around 1948, but the investment vehicle really became en vogue as Richard Dennis and his infamous “Turtles” gained in popularity. Richard Dennis, although working his way up from a runner, really began his reputation as large trader in the 70’s. The 70’s had crop failures to contend with and inflationary conditions which Richard Dennis could use his trend-trading style to position trade. By 1983, he believed that he could teach his methodology to an average woman/man to trade successfully as he had. He had been quoted by the Wall Street Journal in 1989 saying “We are going to grow traders just like they grow turtles in Singapore” thus coining the name “Turtles”! He selected his 21 men and 2 woman to learn the trend-following system with success, increasing his notoriety and adding some new traders to the spotlight. Actually about 60% of the trades may have lost money getting stopped out while the balance of trades were held with trailing stops to garnish more from the position. Other traders sprang up into the spotlight like Paul Tudor Jones and John Henry. The methodology is proprietary to the trader and never really divulged, so the entries, stops and the targets remain exclusive in most managed products. The trading model may take years to cultivate! Futures trading is a zero-sum game where there is a loss for every gain and vice versa. The challenge for the trader was to create a percentage to his/her favor!
In Managed Futures, a Commodity Trading Advisor or CTA may be selected from a wide variety of products. The CTA is registered with the regulatory bodies such as the National Futures Association (NFA). The Commodity Futures Trading Commission may monitor the CTA daily limits in the accounts. The Commitment of Traders Report (COT) is actually a public report that shows the positions of the Managed Futures positions along with others. The CTA may specialize in certain markets or group of markets with perhaps varied time frames, trading styles or risk parameters. The CTA differs from the Commodity Pool Operator or CPO in that the CPO will specialize in a fund or funds offered where money may be pooled and/or they may have strict parameters on exiting the product. The CTA will trade the individual client accounts perhaps through a Trade Manager where the platform may offer an automatic breakdown of orders for each account. The client receives nightly statements and has monies in a customer segregated account under the Futures Commission Merchant or FCM that executes the trades for the CTA. The transparency is beneficial for clients to monitor the activity of the account. Large clients holding many Managed Futures accounts may chart them as a trader may chart the markets exiting ones that do not meet expectations while perhaps expanding interest in those exceeding expectations. Many CTA’s will have a systematic approach to the markets, but that is just a formal way of creating a plan for the program and maintaining the parameters set with consistency. Each product could represent years of back testing prior to offering it to the investment community. A CTA may look for reliability and specific pattern to maintain consistency. The risk may be factored into the equation by a formula to equate a certain risk based on a formula to each commodity product, segment or volatility factor. For example one coffee contract may equate to 6 E-Mini S&P 500 in a mathematical model of a CTA. They may incorporate a mix of markets that may smooth an equity curve or varied time frames. Some traders may incorporate other systems to smooth the equity curve. Sometimes the product mix may be weighted according to the margin required or equity of a product. It is typical to most CTA’s to use the most liquid products for less slippage and easier executions. A stop loss for example turns into a market order when elected but may not fill until the previously entered market orders or stops are filled making liquidity an important part of risk management. The futures contracts themselves are standardized investments that are traded on federally regulated exchanges with responsibilities to overseer the risk and structure of the trading itself.
Investors may enjoy the vast number of products available in Managed Futures. There are some 30+ commodity contracts offered where a CTA may take the long or short side of the transaction. The leverage capabilities in futures trading allows the client or trader the ability to control a quantity of a product with a small good faith deposit. Redemptions in CTA accounts are usually fairly unrestricted. The client may have clarity in that a representative may go through the daily statements to help describe the products and positioning. The client may have transparency in viewing the daily statements to be sure that the expectations are being met for the account.
The fees on a CTA account may be a small management fee of approximately 2% and an incentive fee that may be about 20% just as an example. The Brokerage may charge a round-turn commission with exchange, transaction and NFA fees as well. A fund may charge a front load and/or general management fee which may mean that the account may be down a certain percentage before the first trade is initiated.
When viewing a Disclosure Document which is typically required of the CTA, an investor may wish to look at the annualized rate of return to make sure it is net of fees and trading costs. The Sharpe Ratio may help an investor determine the activity of the managed product verses a product such as the T-Bonds to determine the risk of the managed product. Investors may often refer to the VAMI (Value-Added Monthly Index) chart to determine the growth since the initial investment. The most important part to evaluate is the worst drawdown which may be the loss by percentage from the peak or highest net asset value to the lowest value. The corresponding measurement called Time to Recovery is often overlooked by the CTA in the documentation but of great value to the investor. While the product could exceed the worst drawdown in the future, the numbers may help to determine the risk tolerance to a certain degree.
The investor first may wish to review and evaluate their current portfolio prior to looking into Managed Futures! In reviewing the portfolio, the investor may find that he/she may not be well-balanced for an inflationary climate and wish to look at managed futures that incorporate hedges against inflation such as gold. If an investor finds that the stock portfolio is weighted only with stocks, he/she may wish to look at a managed product that may incorporate Treasuries, currencies and/or tangible products. It is important to note the correlation of various products to attempt to diversify to attain a smooth equity curve.
It is suggested that an investor spend a great deal of time knowing the basics of futures trading, learning about managed futures and tracking various systems and/or CTA’s to get an idea of their consistency over time. Managed Futures is an asset class that should only be used with excess venture capital. A commitment over time is recommended in order for a program to enhance a portfolio. Often investors enter a program and experience an initial drawdown which may create an early exit where a loss could be avoided by going through expectations before investing.
Once an investor may enter a Managed Futures product, it is important to review the daily statements regularly to be sure the product is meeting expectations. It is not out of the question for a client to call in to a CTA to ask about any deviations in the products, style of trading or risk parameters of the program. CTA’s are typically very visible where they or a representative may be available with regularity for any questions or concerns. It is important to get to know the CTA through reputation along with all of the other factors to evaluate. This is only a mere glimpse at Managed Futures perhaps to inform and remind investors that the Managed Futures have been around for many years and may continue through the years. Often the CTA’s of the 70’s and 80’s may have fully staffed offices that trade the model and carry on even with the initial trader retired today!
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By: Leslie Burton
