Investing in Managed Futures
An investor interested in allocating to managed futures should conduct a thorough investigation into the asset class and the selection of a specific investment. The investment could be a CTA program, a private pool or a managed futures mutual fund. The main trade-offs among the three are the number and diversity of offerings, performance, convenience and fees. Separately, managed futures accounts generally are the superior choice for allocations of $100,000 or more, as they provide greater liquidity, transparency and selection. This investment level facilitates the creation of a small portfolio of CTA programs. Below this level, one must assess the pros and cons of single managers vs. multi-manager portfolios/pools/funds.
For separately managed futures accounts, the client opens a futures account through an introducing broker, futures commission merchant (FCM) or directly through a CTA (though he needs a brokerage relationship). The client also will complete an advisory agreement with the CTA. Ownership of separately managed accounts is maintained by the client; all funds are kept at an FCM.
The client and the authorized investment advisor will be provided with online, real-time access to the client’s account. Trade confirmations and monthly statements are sent to the client and authorized investment advisor. The client also has access to consolidated account information through their broker or FCM as long as all accounts go through one FCM. Investing in managed futures via a private pool or mutual fund is subject to the minimum investment levels, requirements and restrictions of each vehicle.
Futures margin is the amount of capital that has to be deposited as collateral in order to gain full exposure to an asset. The margin on a 10-year Treasury note future is $1,155 to control a $100,000 T-note; margin on gold futures is $5,390 to control a 100 oz. contract.
Margin-to-equity (M/E ratio) is the average amount of equity utilized for margin. It is an indication of leverage utilized in a program basis equity, as opposed to the leverage created by margin. For example, the margin on a Treasury bond contract is $2,970 to control a $100,000 contract or about 3%. If an account/program/fund has a margin-to-equity ratio of 20%, it is in effect increasing margin by 5x and reducing the leverage by 80%. For the T-bond example, the CTA is self-imposing an approximate 15% margin per contract. A CTA minimum (nominal) investment level is set at a specific amount. Most CTAs will utilize somewhere between 5% to 20% margin to equity. One can think of this as deleveraging the leverage facilitated by margins.
Notional funding is the term used for the funding of an account below its nominal value in separately managed accounts. Leveraging via notional funds is not like utilizing margin in securities. The use of notional funding does not require an investor to borrow any funds or pay any interest. A CTA or FCM may establish certain restrictions, but this decision is left to the investor for the most part. For example, assume a CTA requires a minimum investment of $1,000,000 (the Nominal Value) and the margin requirement is $50,000. The investor can either deposit $1,000,000 to “fully fund” that minimum investment requirement or the investor can invest only a portion of the $1,000,000, as long as the investor meets the $50,000 margin requirement. Now assume that the investor decides to fund the $1,000,000 account with $500,000 (the “Funding Level”). This means that the investor is using leverage of 2x $500,000, which equals the $1,000,000 minimum investment. The difference between the nominal value ($1,000,000) and the funding level ($500,000) is $500,000. The $500,000 is referred to as “notional funding.”
In essence, the investor is doubling his leverage and would expect to earn or lose roughly twice that of a fully funded account.
The investor has the flexibility to adjust the volatility of the program through notional funding. Risk can be set based on the investor’s appetite. The greatest benefit of managed futures is that it provides non-correlation to other asset classes, particularly in stressful markets.