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Managed Futures FAQ
The information within this brochure has been compiled for the Chicago Mercantile Exchange for general information purposes only. Although every attempt has been made to ensure its accuracy, the Chicago Mercantile Exchange assumes no responsibility for any errors or omissions. Additionally, all examples in this brochure are hypothetical fact situations, used for explanation purposes only, and should not be considered investment advice or the results of actual market experience. Please note that past performance figures are not necessarily indicative of future results.
For the individual or instititutional investor who is simultaneously performance oriented and risk-conscious, the key question is how best to achieve a higher overall rate of return with acceptable risk.
The answer may be a diversified investment portfolio with some portion of the total assets invested in a managed account. That is, an account that utilizes the abilities of a professional Commodity Trading Advisor who is able to bring experience, discipline, and a history of past success to the trading of futures contracts. Past results are not necessarily indicative of future results.
By providing plain language answers to plain language questions, the following can be helpful in deciding whether a managed futures account can help achieve specific investment goals, particularly in today's volatile and increasingly challenging investment markets.
Q. What exactly is a managed futures account?
A . It is like any other brokerage account established to trade in futures except that responsibility for determining what trades to make and at what time, including discretionary authority to direct trading for the account, is delegated to a professional trading advisor. In this sense, the advisor is an account "manager". As will be discussed later, the advisor's compensation is normally a management fee based on the size of the account plus an incentive fee contingent on profitability.
Q. What types of investors utilize managed futures accounts?
A. It's traditionally been individual investors seeking the profit opportunities of futures trading but without the responsibility and demands of day-to-day account management. Recently, however, growing numbers of corporate and institutional investors have been allocating some portion of their total portfolio assets to specially designed and professionally managed futures trading programs. The total amount of capital
in managed futures programs is estimated to exceed $130 billion.
Q. What's been responsible for growth in managed futures trading?
A. Variety of things. As traditional investment markets have become increasingly volatile -and vulnerable to often-unexpected events -- Institutional money management and other sophisticated investors have sought to more effectively manage overall portfolio risk through diversification. Indeed, risk and diversification are major concerns in today's market environment --- along with, of course, yield. A number of studies indicate that a portfolio that includes managed futures can yield appreciably higher and more stable return over time than a portfolio that includes only stocks and bonds.Tthe same evidence indicates this can be achieved without added risk. (See next question.)
Still another factor in the growth of managed futures has been the tremendous broadening of futures markets to encompass stock indexes, debt instruments, currencies, and options as well as conventional commodities. This has created whole new categories of profit opportunities. There is also a substantial risk of loss.
The increasingly global nature of today's futures markets also has expanded the scope of investment opportunities. Finally, from the standpoint of an individual investor, managed futures accounts have proven to be considerably more profitable on the average than accounts that individuals trade on their own.
Q: How are profitability, volatility and risk affected when managed futures are included in an investment portfolio?
A. Harvard Business School Professor John E. Lintner found that including managed futures in a portfolio "reduces volatility while enhancing return." And that such portfolios "have substantially less risk at every possible level of return than portfolios of stocks, or stocks and bonds."
Q. All things considered, why can investment portfolio performance be improved by including managed futures?
A. There's no single reason, but high on the list is that managed futures may perform best when other investments are performing relatively poorly. An important advantage of futures is the opportunity they provide to respond swiftly on a highly leveraged basis whenever and wherever in the financial and commodity markets major price
movements occur — either upward or downward — and to do so without liquidating other investment holdings or adding to overall portfolio risk.
Q. Has the advantage of managed futures trading been increasing in recent years? And, if so, why?
A. Most industry experts agree this has been the case, due in large measure to the increasing complexity of financial markets in general and futures markets in particular. With the complexities have come additional strategies for fine-tuning risk-reward relationships, and for using futures in conjunction with a wide array of other financial products. Recently created worldwide market linkages have likewise placed a
premium on the ability to quickly analyze an act on vast amounts of information. These are capabilities that professional management is best able to provide.
Q. Don't trading advisors differ from one another in their investment results?
A. Definitely. In any given year, some will realize impressive profits and others will incur impressive losses. Still others will occupy the full range of everywhere in between. The success of your managed account will depend on the success of the advisor you select.
Q. That brings up the obvious next question: How do you choose an advisor to invest with?
A. There are a variety of things to consider but in the final analysis it will come down to a judgment call --- yours! It will be a matter of
gathering information, asking questions, and choosing on the basis of your confidence in the advisor's experience and ability. Begin by visiting with futures specialists at the brokerage firm where you are considering establishing an account. Firms that offer managed account programs generally screen the qualifications of dozens of different trading advisors to narrow the list to a few that they feel most confident in recommending at a particular time. Persons registered with the Commodity Futures Trading Commission as Commodity Trading Advisors
are required to provide detailed "Disclosure Documents" to prospective clients. These are similar to a prospectus and contain a wealth of information about the advisor, his experience, approach to futures trading and trading results. Take the time to read them.
Q. How important is the advisor's past trading performance -- the "track record?"
A. As of the ads and prospectuses are required to state, past performance is not indicative of future results. An advisor who has performed
well in the past may perform poorly in the future. And it is possible that someone who has performed poorly may begin to perform well. this
not withstanding, in any endeavor some individuals are obviously better at what they do than others and a track record is at least an
indication of past performance. In addition, a track record can provide other valuable information about an advisor's experience approach to trading, and amount of money under management. You'll also want to note whether performance data included in the disclosure document refers to actual trading results or to "hypothetical" or "simulated" results. Make your own decision about whether to invest in an untested trading system that may be based solely on market hindsight.
Q. What should be considered in examining an advisor's track record?
A. Start by considering the length of the track. Sprinters aren't necessarily successful distance runners. Sensational performance in a short
time span, bluntly put, may reflect little more than extraordinarily good luck. Or, of more concern, it may reflect someone who takes greater risks than you may be comfortable with over the long haul. Or it could reflect specialization in markets that, in a given period, were especially active. Track records can be much more meaningful when you examine a longer track. This provides more information about how an advisor
has performed over the landscape of continuously changing market scenarios. And, very important, performance in less-than-spectacular
years may be indicative of the advisor's risk management skills. That's crucial, particularly in markets that tend to be cyclical.
Q. Which futures markets would I be trading in with a managed account?
A. This will be determined by your trading advisor and in all likelihood it will be different markets at different times. Trading markets will be determined by the trading advisor's trading program.
Q. How do trading advisors differ in their investment approaches?
A. One way is in how aggressively or conservatively they participate in the markets. There also could be differences in which markets they trade. Some specialize in particular areas -- such as financial instruments, metals or agricultural products --- while other pursue profit opportunities wherever they appear to exist. If you have a preference for a particular approach, this should be taken into account. Another difference is whether the advisor employs a "fundamental" of "technical" trading system --- fundamental meaning that trading decisions are based principally on supply and demand, and technical meaning that the markets themselves are continuously analyzed for signals to future
price direction. Even then, different advisors have developed and employ different systems and may read the markets differently. Moreover, the fundamental-technical distinction has broken down somewhat as fundamental advisors frequently employ computerized tools to pinpoint
the timing of their trading decisions.
Q. With a managed account, will I have market positions at all, or nearly all, times?
A. There is another way advisors can differ in their investment approach. Some believe the more profitable way to catch the price movements inherent in volatile markets is to maintain continuous but changing market positions. And their trading systems are designed accordingly.
Others commit capital to the markets only when there is a reasonable confirmation of significant longer-term price trends. In the absence of
such trends, or under certain other market conditions, the advisor may temporarily elect to remain "market neutral". This is not to suggest
that either approach is necessarily better, only that they are different. Which to choose may depend on your own investment temperament
and the capabilities of a particular advisor.
Q. Where will money be when I establish a managed account? A. It will be with the brokerage firm where you have your account. While the trading advisor will direct trading for the account, all other account functions are performed by your brokerage firm, including custody of funds in a segregated customer account.
Q. Is a managed futures account subject to performance bond calls?
A. A performance bond call is a request from the broker to deposit additional funds to the account, generally to cover losses on open
positions; any futures account, managed or otherwise, is subject to them. However, a major objective of professional trading advisors is to manage and diversify their clients' investments in a way that will avoid the necessity for performance bond calls. You may want to inquire
about whether all of your funds will be committed to the market at any one point.
Q. Do managed accounts have any automatic provision to limit losses?
A. If so, this will be described in the disclosure document. A loss of more than some given percentage, or losses that reduce the account
value below a specified dollar amount, may trigger the liquidation of all currently open positions and a subsequent closing of the account.
This "safety valve" feature is clearly one of the things to inquire about when you are considering establishing an account. Keep in mind, however, that no one can guarantee an absolute limit to the extent of losses any more than they can guarantee a given level of profit. Performance, it bears repeating, hinges on the success of your trading advisor.
Q. Who regulates commodity trading advisors?
A. They are regulated by the federal Commodity Futures Trading Commission (CFTC) and by the National Futures Association (NFA), the congressionally authorized self-regulatory organization of the futures industry. All trading advisors must be registered with the CFTC and
those who manage customer accounts must be members of the NFA. * Advisors disclosure documents are required to be submitted to the
CFTC for review in advance of distribution to prospective investors.
Q. On an ongoing basis, how will I know the status of my account?
A. Your brokerage firm will provide the same timely reports you'd receive if you were directing your own account. This includes immediate
mailed reports of all purchases and sales, a marked-to-the-market valuation of open positions, and a month-end summary of transactions,
gains, losses, open positions, and current account value. Your broker, of course, will have the same information, updated at least daily.
Q. With the trading directed by an advisor, is the choice of a brokerage firm still important?
A. It's no less important than in any other investment relationship. On a day-to-day basis, the brokerage firm may be monitoring and
evaluating the advisor's performance even more closely than you will. In addition, although the advisor directs trading for your account,
it is generally your brokerage firm that will execute the trades, and manage all "back office operations" regarding your account. Thus, it's important to know you are doing business with a firm that has the resources and skills to compete effectively in today's markets. Some do, better than others. And intangibly, but by no means least, it's important to have a high comfort level with the broker you'll be working with.
Q. What mistakes do investors sometimes make regarding managed futures accounts?
A. Three probably top the list. First, the fact that a managed account approach may be more attractive than a do-it-yourself trading approach doesn't mean futures trading in any form is necessarily appropriate for a given person. Because risk is the constant shadow of the pursuit of profit, it's definitely not appropriate for everyone. Unless you're confident it's appropriate for you, don't invest at all. Second, as already mentioned, choosing an advisor for the wrong reasons can be a costly mistake. Selecting solely on the basis of "who's hot and who's not"
usually leads to flawed decisions. Third, investors prone to "account jumping" frequently jump the wrong way. This doesn't mean the advisor your start with should forever be the advisor you stay with, but it does mean-and the records document it- that accounts maintained over a longer period of time tend to perform appreciably better than accounts that are in short-term parking. That's all the more reason for
your initial decision to be carefully considered.
Q. How do trading advisors get paid?
A. Normally through a periodic management fee that's some percentage of the amount of money that's under management, plus an incentive fee that's a given percentage of net profits earned for the account during a given period. This will be described in the disclosure document. Some may charge only one type of fee or the other. And if the fee is a combination of the two, different advisors weight it in different ways. Naturally, management expenses as well as brokerage commissions are topics to discuss.
Q. Is there a minimum investment that's needed to establish an account?
A. Yes, but different managed account programs have different minimums. At the least, it will be an amount the advisor and the brokerage
firm-given the trading approach utilized-consider adequate to achieve account diversification. Minimum account size also may be affected by whether the managed account program is designed principally to serve individual investors or institutional/corporate clients.
Q. Are there any restrictions in withdrawing funds from my account?
A. In a private managed account program-as distinct from a commodity pool or fund-the only restriction is usually that you do not make withdrawals below the minimum required investment. You will, however, be free to withdraw all funds after liquidation of any open positions. This can be done at any time of your choosing unless the account agreement stipulates otherwise. Similarly, if there are profits in the account, you are free to withdraw them or leave the money available for reinvestment.
Q. Any final words of advice?
A. Only that if you decide futures trading is an appropriate investment, you give careful thought to the advantages of a managed account approach. And that you choose your trading advisor with considerable care. For the right investors, teamed with the right advisors, today's futures markets are providing increasingly attractive and diverse investment opportunities. Perhaps you should consider them.