From the February 01, 2012 issue of Futures Magazine • Subscribe!

Managed futures mutual funds waiting for green light

Recently, there has been substantial growth in mutual funds utilizing managed-futures-based strategies. The number of distinct managed futures mutual funds doubled to 24 in 2011, according to Morningstar Inc. The funds represent a revolutionary advance in the product mix in managed futures. Once regulatory roadblocks are lifted, the growth of mutual fund products will escalate even more.

Some of the principal attractions to managed futures mutual funds for investors and financial intermediaries are that, in addition to offering exposure to the asset class, they offer daily liquidity. Also, they can be sold, like traditional mutual funds, through omnibus “supermarket” arrangements using electronic “point and click” trading, without the need for investors to fill out subscription documents or applications. However, the regulatory landscape for these products is evolving quickly.

Therefore, it is important that sponsors looking to launch managed futures mutual funds understand the regulatory issues. Recent rulemaking proposals by the Commodity Futures Trading Commission (CFTC) and recent Internal Revenue Service (IRS) policy changes could affect these products (see “The tax man cometh,” last page).

Managed futures mutual funds are regulated by both the CFTC and, pursuant to the 1940 Act, by the Securities and Exchange Commission (SEC). The sponsors of these investment products must understand the restrictions under the 1940 Act that relate to trading futures contracts in a mutual fund. Because of these unique issues, it also is important that compliance officers of these funds (and their managers) implement appropriate policies and procedures designed to prevent violations of applicable law. To further complicate matters, much of the law in this area is uncertain.

Section 18 of the 1940 Act limits the ability of investment companies to issue senior securities, which primarily is intended to restrict an investment company’s ability to create leverage. The SEC has viewed various trading practices, including futures trading, as potentially involving the issuance of senior securities.

To address the leveraging concerns presented by such transactions, the SEC has established guidelines. These generally are set out in no-action letters as well as informal staff positions. They typically require the establishment and maintenance of a segregated account with the investment company’s custodian containing sufficient assets to cover the obligation arising from a particular transaction (Segregated Account). The assets in a Segregated Account must be liquid (and may include equity securities and debt securities of any grade) and marked-to-market daily, and may not be used to cover other obligations.

The SEC has reasoned that a Segregated Account will function as a practical limit on the amount of leverage an investment company may undertake and ensure the availability of adequate funds to meet the obligations arising from such transactions.

Comments
comments powered by Disqus