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Managed Futures

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Managed Futures

 

Individual investors seeking portfolio diversification have been using managed futures for more than 20 years.  More recently, institutional investors, such as corporate and public pension funds, endowments, trusts, and banks, have adopted absolute or total return investment policies rather than benchmarked performance or sectoral approaches. Managed futures, hedge funds and sector specific funds lend themselves readily to this approach.  However, there is also a growing appreciation amongst the investing public of the diversification benefits of managed futures within the traditional investment portfolio.

 

The underlying premise is that, by holding a number of unrelated investments, one can substantially reduce the inherent risk of a portfolio.  Consequently, by combining non- or negatively-correlated investments with traditional stock and bond portfolios an investor can potentially reduce the overall risk or volatility of returns whilst also increasing the return on investment. Academic studies have concluded that an allocation of between 5% and 10% of a traditional stock and bond portfolio to a managed futures program is sufficient to achieve some diversification benefits. It is estimated that nearly $40.6 billion is presently under management by commodity trading advisors.

 

With approximately 1000 Commodity Trading Advisors registered with the National Futures Association, it is important to have access to reliable quantitative and qualitative investment information on any money manager before committing investment dollars.  Whether you are an individual or institutional investor, it is equally important to have confidence in the integrity behind a manager’s track record.

 

Certain managed futures programs are considered securities and are invested through our affiliate

 

History*

 

The first publicly managed futures fund, Futures, Inc., was started in 1949 by Richard Donchian, a broker at the securities firm of Hayden Stone. Donchian is considered to be the creator of the managed futures industry and is credited with developing a systematic approach to futures money management.

 

In 1969, a formal business approach was developed to speculate in the American commodity markets. In that year, Commodities Corporation was founded in Princeton, New Jersey, with US$2.5 million in money under management.

 

Two factors combined in the 1970s and 1980s to underpin a dramatic growth in managed futures. First, the availability of high-powered personal computers and, second, the deregulation of financial markets in general and growth in futures contracts in particular. Together they made the collection and statistical analysis of price data available and created a training ground for young new traders.

 

Until the mid-eighties private investors had dominated the managed futures industries but the introduction of the capital guaranteed fund seriously attracted institutional investors for the first time. The use of a guarantee was used as an alternative to the cessation of trading that some funds normally incorporate into their policy if a threshold loss is reached. They provided a guaranteed return of principle, usually at the end of a five- to seven-year period.

 

This feature was supplemented by SSARIS, a CTA firm of Connecticut, when they also offered a five percent annual return.

 

*Excerpts from Epstein(Ed): Managed Futures in the Institutional Portfolio. Wiley 1992

ISBN 0-471-52983-4

 

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How it Works

 

Managed Futures is an investment in a professional manager or portfolio of managers that trade in futures and options contracts on the client’s behalf. The manager or Commodity Trading Advisor (CTA) is engaged directly by the investor to undertake the trading in accordance with the methodology laid down in the CTA’s disclosure document.

 

Any single CTA will typically trade a variety of markets on any of the world’s regulated futures exchanges. In this way, investors are able to create exposure to a range of markets and economies not readily available through traditional instruments.

 

The trading activity is conducted on recognized futures exchanges throughout the world via a licensed Futures Commission Merchant (FCM) or Broker. As such each market is open, transparent and regulated by the respective Exchange. Each participant in the investment process is licensed, monitored and regulated by the appropriate authority. All monies, deposits or collateral are kept in the client’s own name held in a segregated account by the FCM. CTAs are not permitted to handle client funds. (See Regulatory Framework for more information.)

 

One distinguishing feature of managed accounts is that, by definition, the investment is not made in a fund. Investors are not buying units in a homogenous product. Through a managed account, investors are able to customize their investment to meet their own performance objectives. In this way, clients can direct investments into their preferred markets, sectors or trading methodologies.

 

Clients may invest with a single CTA that is well diversified or may choose to spread their investments among CTAs. Blending of managers allows the investor to diversify manager risk and also combine complementary trading styles or methodologies. By constructing a portfolio of managers, investors can also select specialist managers who display particular performance in specific market segments.

 

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Regulatory Framework

 

National Legislation

Futures markets throughout the world are broadly established the same way. Each Government, under the relevant Act, has typically delegated authority for the establishment, control and regulation of that nation’s futures markets to a regulatory authority. In many cases responsibility is shared between the government authority and a national self-regulated agency or associating. Both organizations have significant power to introduce and enforce laws to ensure the fair and efficient conduct of markets and participants.

 

In the United States of America, home to the world’s largest futures markets, federal legislation introduced in 1974 established the Commodity Futures Trading Commission (CFTC), an independent federal agency with exclusive jurisdiction over futures trading. The legislation also authorized the creation of “registered futures associations.” The National Futures Association was established in 1982 under this provision to: protect the public investor by maintaining the integrity of the marketplace.

 

The CFTC provides government oversight for the entire industry. Each U.S futures exchange operates as a self-regulatory organization, governing the practices of floor brokers, traders and member firms. The NFA regulates every firm or individual who conducts futures trading business with public customers.

 

Similar frameworks exist throughout the world. In the United Kingdom, the Financial Services Authority has been established to oversee the UK financial system including futures and in Australia the Sydney Futures Exchange and the Australian Securities and Investment Commission are empowered by the Corporations Law to license, govern and enforce the conduct and operation of the futures market and its participants.

 

Each association and exchange issue a set of By-laws restricting the activities of members and prescribing how each member class must conduct its business. Failure to comply with these laws may result in heavy fines, expulsion and/or criminal charges.

 

 

Commodity Trading Advisors

Commodity Trading Advisor (CTA) means anyone who, for compensation or profit, engages in the business of advising others, either directly or through publications, as to the value or advisability of trading in futures.

 

Each CTA is licensed to conduct business by an appropriate authority.

 

CTAs must deliver a Disclosure Document for their trading program to prospective clients according to which the client’s trading or account is to be directed. The Disclosure Document must include, among other things:

 

General information

a)         a description of the trading program to be used,

b)         the name of the FCM or IB through which the CTA will trade, or the fact that the client is free to choose the FCM or IB,

c)         the dates on which the CTA began accepting customer accounts and began using the trading program,

d)         the types of commodities to be traded, along with any restrictions or limitations,

e)         the total assets managed by the CTA and traded under the program.

 

Business Background

The business background (not just futures background) for the five years preceding the date of the document for the CTA and each principal involved in the day-to-day operations of the firm.

 

Performance Record

a)         the actual performance record of the CTA and each principal for the five years prior to the date of the document. If they have not previously directed an account, this fact must be prominently disclosed in a form prescribed by the CFTC.

b)         for the program being offered, monthly rates of return, in either a numerical table or a bar graph, for the five calendar years and the current year to date.

c)         worst monthly drawdown and worst peak-to-valley drawdown for the trading program over the past five calendar years and the current year to date.

d)         performance information may be shown on an individual or composite basis. If individual then material differences among the accounts must be shown. If composite, then the CTA must describe how each composite was developed and disclose material information from which the composite was drawn.

 

Fees

Conflicts of Interest

Self trading

 

Litigation

a)         any material administrative, civil or criminal action within the five years preceding the date of the document made against the CTA or its principals or the FCM or IB or its principals,

b)         if there has been no such action, a statement need not be made to that effect.

 

Risk Disclosure

a)         a Risk Disclosure Statement must be prominently disclosed on the first page of the document in a form prescribed by the CFTC.

 

Other Requirements

In addition to the form and content of the Disclosure Document and Risk Disclosure Statement, the CFTC also requires CTAs to maintain financial records in the manner they prescribe and to treat all clients equally.

 

 

Brokers and Futures Commission Merchants

The Exchanges throughout the world, under legislation, have responsibility for the regulation and control of member FCMs or Brokers. Exchanges and each country’s corporate regulator have far reaching power and authority to enforce these rules and prosecute firms found to be in non-compliance.

 

Granite

Similarly, Granite Capital of California, as a member firm of the National Futures Association, is bound to conduct business in the prescribed way. Granite is required to lodge quarterly returns to the NFA to demonstrate that it is in compliance. All promotional material that Granite distributes, including the contents of this website, must be reviewed and authorized by the NFA. The NFA has the power to audit members without notice and may, at its discretion, impose fines or expel member firms for breaches of the business rules.

 

For further information on the regulatory framework in particular jurisdictions refer to the following websites:

 

U.S.A:                         National Futures Association or Commodity Futures Trading Commission

United Kingdom:       Financial Services Authority

Australia:                   Sydney Futures Exchange or Australian Securities Investment Commission

 

 

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The Futures Markets

 

Client Protection*

Trading volume in futures contracts and options on futures on U.S markets has risen to more than 500 million contracts annually. And the dollar value of futures contracts traded currently exceeds several fold the dollar value of common stocks traded on all US stock exchanges.

 

A requisite for this growth has been the financial integrity of futures markets. While trading in futures contracts obviously involves risks related to price changes, market participants have historically had little reason to be concerned about the security of their funds. Customer losses due to the insolvency of a futures brokerage firm have been virtually non-existent. Indeed, such losses have totaled less over 50 years than the Securities Investor Protection Corporation has paid, on the average, to reimburse customers of the securities industry for member firm insolvency losses each year.

 

For anyone considering participation in the nation’s futures markets, the reasons behind this continuing and impressive record of financial soundness are worth knowing.

 

Daily Cash Settlement

As futures prices move upward and downward, the market value of customer open positions increases and decreases. Resulting gains and losses from futures trading are credited or charged to each customer’s account each day following the close of trading. Subject to existing margin requirements, all gains deposited to a customer’s account through this procedure become immediately available to the customer.

 

Margin Requirements

Buyers and sellers of futures contracts are required to at all time maintain sufficient funds on deposit in their brokerage accounts to cover losses that might be incurred as a result of price changes. Margin deposits provide protection for all market participants. In volatile markets, the exchanges increase margin requirements accordingly. The availability of such funds is what makes daily cash settlements possible under all market conditions.

 

The Exchange Clearing House

Once each purchase of a futures contract is precisely matched to the corresponding sale (a process which occurs each day), the clearing organization of the exchange where the contracts are traded becomes the “buyer to every seller and the seller to every buyer”. The purpose: to provide a mechanism that assures the payment of all gains and collection of all losses on a daily basis.

 

Capital Requirements

Every firm that conducts business with the public as a Futures Commission Merchant must have and maintain sufficient capital to meet its financial obligations to its customers. These requirements are subject to continuous audit and stringent enforcement. Regulatory agencies have the authority to determine compliance on a daily basis and in volatile markets clearing organizations can demand that a firm provide additional capital on one hour’s notice!