| Some
information within this question and answer page
has been compiled from the Chicago Mercantile
Exchange brochure for general information purposes
only. It has been provided courtesy of the Chicago
Mercantile Exchange and is distributed free of
charge. The Chicago Mercantile Exchange assumes
no responsibility for any errors or omissions.
Additionally, all examples in this FAQ 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.
Table of Contents:
Scroll through the entire FAQ sheet or click to
go to a topic below.
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Introduction
The key question often asked today 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 futures account,
which is an account that utilizes the abilities
of a professional Commodity Trading Advisor who's
able to bring experience, discipline, and a history
of past success to the trading of futures contracts.
The questions that follow 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.
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What exactly is a managed futures account?
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.
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Why managed futures?
With practically a zero correlation with stocks,
one of the most attractive features of managed
futures is its ability to add profound diversification
to an overall investment portfolio. The ability
of futures to enhance the returns of traditional
investments has been documented in a study conducted
by Goldman Sachs. Covering a 25-year period, the
study concluded that by "allocating
only 10% of a securities portfolio to commodities,
investors can vastly improve their performance."
Goldman Sachs' conclusion, concerning the value
of commodities, was supported by another study
published by the Chicago Mercantile Exchange,
one of the world's preeminent futures exchanges.
According to the CME study, "Portfolios
with as much as 20% of assets in managed futures
yielded up to 50% more than a portfolio of stocks
and bonds alone."
The Chicago Board of Trade's
booklet, Managed Futures, Portfolio Diversification
Opportunities, shows a portfolio with the greatest
risk and least returns comprised of 55% stocks,
45% bonds, and 0% managed futures while a portfolio
exhibiting the greatest returns and least risk,
comprised 45% stocks, 35% bonds, and 20% managed
futures.
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What types of investors utilize managed futures
accounts?
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.
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Are Professionally Managed Futures suitable for
everyone?
No, they are not. We would first interview you
to determine your suitability and provide you
with all of the necessary information to make
sure you understand both the risks and rewards
of this type of investing. Generally, in addition
to having the required risk capital, an investor
needs to have realistic expectations about returns
on investment, tolerance to temporary draw downs
that inevitably will occur, and acceptance of
the reality that the risk of loss always exists.
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What has been responsible for the 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 managers 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 an appreciably
higher and more stable return over time than a
portfolio that includes only stocks and bonds.
The 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.
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. (See Question: How does the
performance of managed futures accounts compare
with those of self-directed accounts?)
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How are profitability, volatility and risk affected
when managed futures are included in an investment
portfolio?
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.
For the period January 1, 1980
to December 31, 1998, data show that managed futures
investments (as measured by the Barclay CTA Index)
had a compound annual return of 15.8%. That compares
very favorably with the 17.7% return that common
stocks had during the same period, one of the
strongest stock markets in U.S. history. Further,
it exceeded the 11.8% compound return on bonds.
Moreover, during a similar period (Jan 1, 1980
to Dec 31, 1997), analysis showed that a portfolio
that was comprised of some managed futures had
similar profitability with far less risk.
| Portfolio |
Return
DuringPeriod |
Risk(Std.
Deviation) |
| 55% Stocks / 45%
Bonds / 0% managed futures |
14.5% |
9.55 |
| 50% Stocks / 40%
Bonds / 10% managed futures |
14.9% |
8.9 |
| 45% Stocks / 35%
Bonds / 20% managed futures |
15.1% |
8.7 |
| 37% Stocks / 27%
Bonds / 36% managed futures |
15.6% |
9.25 |
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All things considered, why can investment portfolio
performance be improved by including managed futures?
There's no single reason, but high on the list
is that managed futures may perform best when
other investments are performing relatively poorly.
On the occasions of the S&P 500's two worst
declines during the past decade, managed futures
recorded net profits of 9.7% and 18.6%. A study
by University of Massachusetts Finance Professor
Thomas Schneeweis compared the S&P's worst
12 months and best 12 months since 1985 and found
that managed futures posted gains during both
periods.
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.
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Is a managed futures account appropriate as a
short-term investment?
No. Futures markets, like most markets, tend to
be cyclical. Moreover, even an advisor who is
highly successful over the course of a year may
-- and probably will -- experience some months
in which losses are incurred. Thus, while you
are free to close an account at any time, it's
probably not a prudent investment strategy to
establish an account that you don't plan to maintain
for at least a year.
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Why is Professional Management necessary and does
having a managed account lessen risk in a portfolio?
In our opinion, Professional Management is necessary
because the futures markets are very complex and
trading experience, as well as, trading skills
are largely responsible for success in this arena.
Profitable trading requires discipline and temperament
to respond to movements in the market; in addition
to knowing when and how to liquidate positions
as a part of a predetermined trading plan. All
this has to be done systematically in the face
of emotion to adhere to a proprietary plan designed
to return profits. Futures trading involves risk.
The same leverage and market movements that can
produce profits can also produce losses. This
same scenario can occur in a professionally managed
account; however, one characteristic investors
should look for in a CTA is a demonstrated ability
to successfully manage risk over the long term.
You must understand that losses can occur regardless
who is managing your money.
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Can you give an example of "Leverage"?
If you are already familiar with the arithmetic
of futures, this will be nothing new to you. Still,
an example illustrates the reason for having some
part of a total investment portfolio positioned
to participate in profit opportunities as and
when there are significant price movements virtually
anywhere in the economy.
Example: Assume there
are indications that the U.S. dollar will increase
in value. Consequently, the value of a Swiss franc
is expected to drop from 65.00 cents to perhaps
only 60.00 cents. With a performance bond deposit
of about $10,000, you could establish a short
position in 6 Swiss franc futures. (Each Swiss
francs futures contract equals 125,000 Swiss francs.)
If the price declines by the expected 5.00 cents,
the profit on the $10,000 performance bond deposit
will be $37,500 (.05 x 125,000 x 6). That's leverage.
Now take the example one step
further and assume the $10,000 performance bond
deposit was part of a $50,000 managed futures
account and that you also have $150,000 in stock
and bond investments with an average annual return
of 12%. Even if the Swiss franc contracts represented
the total net futures profit for the year, a $37,500
gain would double the overall portfolio return
for the year. Yet only 5% of the total $200,000
portfolio was invested in the futures positions.
In the context of portfolio management, that's
the significance of leverage.
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How does the performance of managed futures accounts
compare to self-directed accounts?
Some individual investors -- those who have the
know-how, time, access to information, and necessary
temperament -- are highly successful in directing
their own futures trading. Unfortunately, however,
the record suggests that only a small percentage
of "do-it-yourself" futures traders
possess these requisites for success. Studies
indicate that somewhere between two out of three
and nine out of ten lose money. However, of the
119 funds and pools in the Managed Account Reports
Fund/ Pool Qualified Universe Index that traded
from January 1990 through October 1996, 81% were
profitable over the full time period.
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Has the advantage of managed futures trading been
increasing in recent years, and if so, why?
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 and act on vast amounts of information.
These are capabilities that professional management
is generally best able to provide. For example,
most successful trading advisors monitor a large
number of different markets and market relationships
simultaneously and continuously. This can translate
into a faster response to profit opportunities
and an earlier warning to retreat from unattractive
market positions.
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Are there other reasons why managed accounts are
generally more profitable?
The growing complexity of the markets is one factor
but by no means the only factor. As in most areas
of investment, trading experience and trading
skills are ultimately major determinants of trading
success. Profitable futures trading requires the
discipline and temperament to respond to market
realities if and when they conflict with market
expectations. It requires a keen knowledge of
when and how to establish positions and when and
how to liquidate them. It requires the development
and implementation of carefully considered trading
strategies -- a trading plan and a trading system.
And the list goes on. Effective account diversification
demands an insightful understanding of how various
markets react with and to one another. Otherwise,
attempts to diversify could prove illusory. Even
institutional and corporate portfolio managers
who may have experience in futures -- such as
for hedging applications -- generally choose to
use professional commodity trading advisors to
manage their futures trading investments. For
most individual investors, the advantages can
be even greater.
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How do you choose a commodity trading advisor?
The basic requirements are:
[1] The Investment Requirement
which varies from CTA to CTA based on their trading
style.
[2] The Return Potential based
on the historical performance track record from
the disclosure document must be attractive to
you.
[3] The Level of Risk which must
be tolerable by you.
Your goal should be to choose
an advisor who employs a trading plan that parallels
your investment disposition - aggressive, less
aggressive or somewhere in between. Also, your
CTA should make money for you, but not cause you
to have "sleepless nights" in the process
because of intolerable risk.
There are a variety of things
to consider but in the final analysis it will
come down to a judgment call -- yours! Commodity
Trading Advisors are required to provide detailed
"Disclosure Documents" to prospective
clients. These contain a wealth of information
about the advisor, his experience, approach to
futures trading, and trading results. Take time
to read them.
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Which futures markets would I be trading in with
a managed account?
This will be determined by your trading advisor
and in all likelihood it will be different markets
at different times.
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How do advisors differ in their investment approaches?
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 others pursue profit opportunities wherever
they appear to exist. Another difference is whether
the advisor employs a "fundamental"
or "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.
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With a managed account, will I have market positions
at all, or nearly all times?
This is another way trading advisors can differ
in their investment approach. Some believe the
most profitable way to capture 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 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.
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Where will my money be when I establish a managed
account?
It will be with the registered Futures Commission
Merchant (FCM) / Bank where you have your account.
While the trading advisor will direct trading
for the account, all other account functions are
performed by your FCM / Bank, including custody
of funds in a segregated customer account.
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Is a managed futures account subject to performance
bond (margin) calls?
A performance bond (margin) call is a request
from the FCM / Bank 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 (margin) calls. You may want to inquire about
whether all of your funds will be committed to
the market at any one point in time.
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Do managed accounts have any automatic provisions
to limit losses?
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, under advice
to the client. 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.
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Who regulates Commodity Trading Advisors (CTA's)?
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 either
be registered with the CFTC or be exempted from
registration under certain applicable laws.
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On an on-going basis, how will I know the status
of my account?
Your FCM / Bank 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 CTA, of course, will
have the same information, updated at least daily.
In some instances the FCM / Bank may provide the
client with an online ‘view only’
facility of their account details.
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With trading directed by an advisor, is the choice
of a Futures Commission Merchant (FCM) / Bank
still important?
It's no less important than in any other investment
relationship. On a day-today basis, the FCM /
Bank 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 FCM / Bank
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 FCM / Bank you'll be working
with.
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What mistakes do investors sometimes make regarding
managed futures accounts?
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 you
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.
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How do trading advisors get paid?
Normally through a periodic management fee that's
some percentage of the amount of money 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.
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Is there a minimum investment needed to establish
an account?
Yes, but different managed account programs have
different minimums. At the least, it will be an
amount the advisor and FCM / Bank (given the trading
approach utilized) consider adequate to achieve
account diversification. Investors would be well
advised not to establish an account with a very
small investment as they would be induced to use
exceptionally high leverage and thereby result
in a mathematical disadvantage at the inception
of trading itself. Minimum account size also may
be affected by whether the managed account program
is designed principally to serve individual investors
or institution / corporate clients.
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Are there any restrictions on withdrawing funds
from the account?
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 and completion of your lock-in
period (if any) as stipulated in the account agreement
with your advisor. Similarly, if there are profits
in the account, you are free to withdraw them
or leave the money available for reinvestment.
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Procedural Table
|
Client indicates interest in
our service |
|
Risk Reward Management will
interview the client for suitability and brief
them about the risks involved |
|
Risk Reward Management will
assist the client with the necessary documentation |
|
Documents will be sent to the
FCM / Bank for processing |
|
FCM / Bank scrutinizes the
application & related documents and (if
found in order) instructs the client to remit
the funds |
|
Client remits the funds through
his bankers |
|
On receipt of funds the FCM/Bank
activates the account and intimates the client
/ Advisor |
|
Risk Reward Management commences
the advisory service |
|
Client is informed of the progress
periodically |
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Any final words of advice?
Only that if you decide futures trading is an
appropriate investment, 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.
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