As equity markets continue to be plagued with volatility while markets adjust to a shift in the global economy, investors are correct to seek diversifiers and instruments to reduce portfolio correlation in an increasingly correlated world. CTA’s (or commodity trading advisors) have proven to provide diversification to a traditional debt/equity portfolio and decrease volatility at portfolio level owing to their lack of correlation with other asset classes. CTA’s are commonly structured as offshore open ended funds so when assessing suitability is not so much a case of CTA Vs. Hedge Fund, as much as “what type of hedge fund is this CTA”. You will often hear them referred to as managed futures due to the prevalent utilisation of futures contracts in the fund and traditionally there has been a focus on commodities. Presently, these strategies are not limited to commodities, but those with commodities exposure are numerous. These managed futures funds are highly liquid strategies investing in, and via exchange-traded futures, forwards, options, and foreign exchange markets. Trading programs can take both long and short positions in as many as 350 globally diverse markets and as such are efficient portfolio diversifiers, working alongside traditional asset classes to improve a portfolio’s sharpe ratio.
Within the CTA universe there will be much variation in the extent to which any given strategy will use the breadth of instruments and strategies available to it under its investment memorandum. Primarily, care should be taken to assess the amount of leverage deployed in the strategy as this will commonly manifest itself in large potential volatility unless return variance is expertly managed. As a rule of thumb, strategies that employ more leverage can generally be seen to display more extreme kurtosis than that of traditional long-only equity based funds and considerably more tail risk. Because of this, it is advisable to employ a quantitative portfolio construction methodology so as to map out where a CTA fund fits into your existing portfolio corellatively, so as to not increase overall volatility. Once you understand what type of return profile it is that you are looking for, it is likely that there will be a CTA in existence which fits your requirements. It should not surprise you that accessing these absolute return investments commonly producing high returns is often not very simple.
Minimum Investment Amounts
Due to the often specialist nature of managed futures they are not suitable investments for novice investors. The use of derivatives and potential utilisation of leverage requires a certain level of investor savvy not always met among individual retail investors. Because of this, some jurisdictions (depending on where the fund is incorporated/strategy is administrated from) will restrict investment into these funds to “professional investors” or “high net worth individuals” so as to predicate a sufficient level of understanding, and to insulate an investor from an irreparable degrees of loss in the event of strategy failure. Minimum funding requirements are often as much as 1,000,000 USD with some strategies requiring a commitment of up to 3,000,000 USD. As more managed futures strategies become available in the market the capital raising environment becomes more competitive and we have gradually seen an decrease in the minimum investment requirements. It is important to note that a fund with a larger minimum investment is not necessarily better. As strategies are investing in highly liquid instruments, a large AUM also does not hamper performance in the same way that is often the case with large equity funds where the opportunities to deploy capital in accordance with the investment memorandum become limited. This withstanding, larger CTA’s (100 Mln+) often achieve their critical mass by virtue of low variance of returns which is more appealing to institutional investors. Smaller CTA’s have the tendency to target spectacular returns in their infancy, and then scale back risk as they mature so as to reach a larger, more capitalised audience. There are ways to access this performance without investing millions, and sometimes you may be lucky enough to invest in a strategy in its infancy with a nominal sum, participate in its stellar performance, and ride it up into the 100Mln$+ category (whereby they often stop accepting new subscriptions for “small money“).
Indexation of managed futures strategies is conceivably problematic (differing frequency of NAV calculation, no universal reporting standard, geographical dispersion of funds etc.) but for the purpose of performance tracking there is no shortage of places to look. The following are some reliable composite indices.
Barclay BTOP50 Index
Barclay CTA Index
Barclay Systematic Traders Index
CISDM CTA Equal Weighted Index
Credit Suisse Managed Futures Hedge Fund Index
Newedge CTA Index
Newedge CTA Trend Index
Stark 300 Trader Index
Stark Systematic Trader Index
These indices track from between 10 to 300 different strategies and can provide a snapshot of performance in a particular part of the managed futures landscape. As for investing in managed futures using ETF’s (which do not have million dollar minimums), there are some options. At present a cursory search of etfdb.com yields the following three options. It is worth noting that there have been very few additions to this space in the past 4 years and the number of ETF’s closing down greatly exceeds the new additions.
|WDTI||Managed Futures Strategy Fund||$41.71||-0.02%||$196,037||33,953||-0.2%|
|FMF||First Trust Morningstar Managed Futures Strategy Fund||$46.91||-2.07%||$9,674||1,820||-4.7%|
|FUTS||ProShares Managed Futures Strategy ETF||$20.01||0.00%||$3,003||8,710||-3.6%|
* Assets in thousands of U.S. Dollars. Assets and Average Volume as of 2016-03-30 20:19:03 UTC
Perhaps uncharacteristically of ETF’s, CTA index tracking ETF’s usually have a comparatively high TER owing to the complexity and expense incurred in replicating the performance of a basket of very different strategies. The performance is also often surprisingly poor compared to that of the index itself (as is often the case with leveraged ETFs) and many would argue that the only benefit to a tracker in this instance would be the tiny minimum investment requirements (as is the case with any type of ETF). ETF based trackers are also reductive in their exposure, as it is nigh-on impossible to representatively replicate the performance of the entire managed futures space owing to the sheer number and diversity of its participant strategies. If you have more than 10,000 USD at your disposal then you will likely be able to access a strategy directly instead using a wrap account.
Discretionary Managed Accounts
Many strategies and advisers registered with the National Futures Association will choose to manage client money on a DFM basis through a broker. This is a common springboard for many strategies until they gather sufficient AUM to justify the cost of fund incorporation and the ongoing maintenance fees. The brokerage platforms offering this capability often offer in-house compliance, CRM, reporting and analytics as part of the package and enable fund managers access to a low-cost and intuitive platform upon which to grow the fund. Investing via a discretionary managed account is relatively simple. The client signs up for an account with the brokerage as usual, and then permits the fund adviser discretionary authority to conduct trades on the clients account. The advisor’s authority will be limited to trade management and they will not be able to perform cash transactions; deposits, withdrawals etc. on your behalf. As with most things, there is still a barrier to entry. CTA’s will be classified as “professional investor funds” and will require that you self-certify yourself as a professional investor or high net worth individual (HNWI) through a questionnaire clarifying your investment experience and current available assets. Qualifying as a HNWI with an online brokerage is decidedly less onerous than engaging with a fund directly (an LLP structure, for example) as they may be obligated to confirm client liquidity, whereas an online brokerage commonly takes your word for it if you check the right boxes…
Particularly common in the US, onshore funds will commonly be registered in states with amenable taxation laws. Globally, the US can be thought of as the hub for CTA’s owing to the its central part in the history of the futures industry but it presently accounts for less than half of the managed futures universe. Onshore funds are generally the best option for US Taxpayers who would otherwise face reporting and tax complications in-line with the IRS treatment of “PFIC’S” or passive foreign investment companies if the investor were to invest in a fund domiciled overseas. Engaging an onshore fund generally works on a subscription basis, in line with the terms and conditions set out in the offering memorandum and prospectus. There are standardized reporting requirements for all NFA registered members and owing to the strict regulatory environment they are able to boast a relatively high degree of transparency when compared to offshore funds. Onshore funds are generally less able to reduce tax liability than their offshore peers and as such may have more performance drag. This alone should not influence allocation decisions as arguably, an onshore fund with robust performance and a long term track-record would still be more attractive than an offshore fund with stellar returns, but little in the way of track-record. Domicility of the fund should be taken into consideration with regards to the clients tax situation, and not the other way around.
Offshore funds currently make up the majority of all managed futures strategies in existence. Owing to the often sophisticated investment methodologies followed, many managers are unable to run strategies under a European UCITS 3 compliant format which may restrict the activities of the fund and negatively impact the ability to deploy leverage. Because of this, and the welcoming regulatory environment of their jurisdictions, many CTA’s are registered in offshore centers like the Cayman Islands, Barbados and the British Virgin Islands. By virtue of being operated “offshore” these funds are generally easier to access than onshore funds and commonly the “professional investor” requirements are less high. Again, nothing about the performance of a strategy can be inferred from where it operates, but it is prudent to understand where the business takes place and to whom audits and performance data are submitted. At present there are many offshore CTA’s with 100,000 USD minimum subscriptions. This is particularly true for strategies domiciled in the Cayman Islands, in-line with CIMA regulations that dictate that 100,000USD should be the minimum for professional investor funds. This is still too lofty a commitment for the vast majority of retail investors. Using a wrap-account, often administered by large insurance companies, clients often are able to subscribe to these strategies for a reduced minimum investment of 10,000 USD. This is achieved by having the dealing done on your behalf by the insurance company, who already have professional investor status, and are able to bulk-trade; satisfying the minimum subscription requirements of the respective regulators. As such this is a better way to directly invest in quality funds, at a reasonable commitment level, rather than settling for the mediocre performance of an index tracker.
In summary, it is often not as simple as making a phone call to your bank to open a CTA account but the benefits of these strategies far outweigh the inconvenience. Any addition to your portfolio that will increase your risk-adjusted returns will be invaluable when building a robust portfolio and the ability of managed futures to reduce drawdown cannot be ignored. Consider allocating to CTA’s alongside a basket of other absolute return strategies in your diversified portfolio.
– Facts and Fantasies about Commodity Futures ∗ Gary Gorton The Wharton School, University of Pennsylvania and National Bureau of Economic Research and K. Geert Rouwenhorst School of Management, Yale University June 2004 This Draft: February 28, 2005
– National Futures Association
– Caymand Islands Monetary Authority
– Dillion Eustace: a guide to hedge funds in the Cayman Islands
– CME Group: Litner Revisited; A Quantitative Analysis of Managed Futures Strategies
– Vision Financial Markets: Factual Studies on Managed Futures Interaction with Stocks