Managed Futures Funds- Another investment option

Individual and institutional investors search for alternative investment vehicles when traditional markets offer lackluster returns. At these times, they often shift investments to managed future funds for better returns.

The managed futures industry is an investment field made up of professional money managers who have licenses as commodity trading advisors or CTAs. These CTAs are required to register with the Commodity Futures Trading Commission (CFTC) prior to soliciting the public for investments.

Most CTAs must pass the series three exam administered by the National Futures Association (NFA) to demonstrate proficiency in the field. CTAs also undergo background checks and must provide their investors with copious disclosure documents, which the NFA reviews for accuracy and compliance with regulatory rules.

In these managed futures funds, CTAs manage their customer's assets by employing trading systems they design to take advantage of moves in futures markets. These futures contracts represent price action in commodities, equities, debt and foreign exchange markets. Futures offer a great deal of leverage therefore; both risk and reward in managed futures funds can be higher than in other investment vehicles. At the same time, many studies indicate that a diversified portfolio that includes managed futures funds will actually lower overall portfolio risk. One of the most important arguments for including managed futures into an investment portfolio is that these investment vehicles have a negative correlation with major asset groups.

As an example, during periods of inflationary pressures managed funds that track metals like gold and silver or foreign currency futures can provide a hedge to the damage that can be done to traditional investment vehicles like stocks or bonds.

When evaluating a managed futures program much of the information that you need is in the disclosure documentation, which is prepared under the rules and regulations of the CFTC and NFA.

This documentation outlines the CTAs trading plan and fee structure. Generally, CTAs charge investors around a 2% management fee and they charge 20% of the profits as a performance incentive. The managed fund charges the incentive fee only when it produces positive returns however; the management fees are regardless of performance.

A drawdown is a period where a CTA experiences negative results in their managed fund. The disclosure documentation contains information on the money manager's peak-to-valley drawdown, which is the largest cumulative decline in the value of the trading account. This information does not guaranty that a drawdown in the future will be the same as historical ones. On a historical basis, the shorter the time required to recover from a drawdown the better in terms of a managed funds performance profile. CTA's and managed futures funds assess performance fees on new net profits. When they lose money for a customer, a "high water market' establishes the level at which incentive fees can be charged once again.

The disclosure documentation also includes information about the fund's annualized rate of return and risk-adjusted return. The annualized rate of return is the percentage gained or lost by the CTA net of fees and trading costs. CTA's must update their documentation every nine months but one can request more up to date information from these money managers. The risk adjusted return can be determined by using a variety of statistical methods that measure the funds return versus the amount of risk. The Sharpe or Calmar Ratios are examples of these statistical methods.

Investors who place money with CTAs in managed futures accounts can view all of the trading activity associated with their account. Generally, a CTA works with a Futures Commission Merchant (FCM) and does not share in commissions on execution of trades. When CTAs do share in these commissions, a conflict of interest can arise. To invest with a CTA one must be a qualified investor who meets certain net-worth criteria. Each CTA has a minimum investment account size. Investment minimums can range from as low as $25,000 to as high as $5,000,000 for the most successful managed future fund operators.

Managed Futures Funds are alternative investment vehicles that provide investors with another alternative in the ever-expanding world of financial products.

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