The phone calls and emails started coming in heavy Monday, October 7th. When are you guys going to put up a response to the Bloomberg piece? Where’s your Bloomberg rebuttal? We need you guys to write something to defend the industry… and so on, the comments went. And while we were tempted to tell a lot of these people to do their own work, get your own blog, or to have the “industry” send over a check for doing a ‘rebuttal’… the truth of the matter was the article was so abrasive that we were already half finished with our response by the time the digital ink was dry on Bloomberg’s take down of the whole managed futures industry for the sins of a few.
But the article was so egregious in its generalizations, so obviously out of context with misquotes of good people like Gerry Corcoran, and so set with an agenda in its tone against ‘futures funds’ – that we wanted to shoot bigger than just our little slice of the world talking to people in the managed futures space already. Bloomberg News shouted from the rooftops that managed futures investors were fleeced, and we wanted to shout just as loud from a different rooftop, not from down on the street. So we submitted our response as an Op Ed to Bloomberg, to the WSJ, to Reuters, to CNBC, and more. The general response was best summed up by one editor who said it was too detailed… Too detailed? Too detailed in response to an article claiming quite a specific, detailed thing – that 89% of gains from futures funds are eaten up by fees?
So, two weeks and a handful of editor rejections after the Bloomberg piece hit the internet, we’re back where we should have probably just started in the first place – posting our thoughts on the ‘Fleeced by Fees’ article on our blog. Here’s our response to the Bloomberg Magazine piece:
No, Bloomberg, the managed futures industry is not a scam
Is the managed futures industry a scam? Bloomberg would surely have you think so with its sensationalized headline “How Investors Lose 89 Percent of Gains from Futures Funds”. And I guess we should expect an article like this with stocks at all time highs, attacking an asset class that performs as a diversifier and has not gone up in tandem with stocks.
But who exactly is Bloomberg talking about? Is that all ‘futures funds’? Is that the entire Managed Futures Industry? Bloomberg would sure have you believe so via its numerous implications and insinuations – but the fact of the matter is they reviewed just 63 funds, out of 6000 total registered commodity pools.
Now, we couldn’t agree more that the bulk of the managed futures funds they reviewed (the ones sold by Wall Street banks and broker/dealer networks) are overburdened with additional fees and bad for investors. In fact – we would argue that most funds sold by broker/dealer networks are overburdened with fees and bad for investors.
But their highly selective “research” is an insult to the many hard working, fair folks in the managed futures industry who take serious offense to the implication that ‘Managed Futures’ is the “single biggest rip-off on Wall Street,” as a copy cat article by Gawker stated.
This isn’t a case of the managed futures industry being flawed. It isn’t even about managed futures. It’s about Wall Street ripping people off through their packaging of product. It is about layering fees on top of fees to create access to an asset class. The example was managed futures, but the cause is packaging. It’s the same story we’ve seen in terms of packaging mortgages, penny stocks, IPOs, junk bonds, credit default swaps, and more.
What is Managed Futures?
Managed Futures is an alternative investment style which provides investors with global diversification by going both long and short across the major market sectors (fixed income, stock indices, currencies, and commodities). The strategy is perhaps best known for its stellar performance during the financial crisis (where managed futures indices gained around 14% as the S&P 500 fell -37%), and as Bloomberg pointed out – for being the source of wealth for Boston Red Sox owner John Henry, who made his fortune via a privately offered managed futures fund distributed mainly by Merrill Lynch in the 80′s and 90′s.
But the press consistently loses track of managed futures at right about that point – throwing the term ‘funds’ into their title as they interchangeably refer to managed futures as: ‘managed futures funds’, ‘futures hedge funds’, ‘commodity funds’, and so on. The press consistently ignores that a large amount of managed futures is not done inside of funds.
Managed Accounts (base cost)
Managed Futures’ backbone is actually individually managed accounts. The terms ‘Managed Futures Account’, and ‘Managed Account Platforms’ are derived from the practice of professionals, registered with the Commodity Futures Trading Commission (CFTC) via the National Futures Association (NFA) as commodity trading advisors (CTAs), actually managing each client’s individual account, placing trades in the client’s accounts directly on their behalf like their own personal futures trader. The cost of individually managed accounts are simply the managers fee, normally referred to as “2&20”, a 2% annual management fee and 20% incentive fee based on net new profits generated; and the trading commissions and fees (~1% to 3% annually).
Privately Offered Managed Futures Funds (0% to 3% in additional costs)
Now, here’s where the media gets confused – it can require an investment of $250,000 to $10 million to access managed futures via an individually managed account. That obviously limits the universe of possible investors. So enterprising managers looking to reach more customers from privately offered funds called ‘Commodity Pools’, which must register with the Commodity Futures Trading Commission (CFTC) via the National Futures Association (NFA). Commodity Pools are technically hedge funds, as they are privately offered securities usually formed as limited partnership type companies, so the managed futures account suddenly becomes a managed futures hedge fund, thus the confusion around the terminology. While some of these Commodity Pools/managed futures funds may incur additional costs of between 1% and 3% to cover the pool operator’s management, legal setup, administration, and audit fees, other trading advisors reduce their management fee or operate the fund themselves so as not to burden the fund with additional fees and impact performance.
And here’s where it takes another turn. You see – privately offered funds can’t advertise (until recently with the JOBS Act, although they still have to file to do so), so they are technically limited to only soliciting people they know for investment – or have the fund offered through a broker/dealer. And that’s where a great investment product and portfolio diversifier can turn into an overpriced Wall Street nightmare.
B/D Offered Managed Futures Funds (+1% to 3% up front, +1% to 2% ongoing in costs)
Broker/Dealers!! Eureka, most managers would think. The broker/dealer has 10′s of thousands of clients, which could take me to $1 Billion in assets and beyond. They sure can, but as the Bloomberg article correctly lays out in a quote from Thomas Schneeweis, a finance professor at the University of Massachusetts Amherst.
“These things are sold, not bought.”
And who is doing the selling? Wirehouse brokers. And how do those brokers get paid? Upfront fees, aka front end loads, and trailing selling fees. And do they have a fiduciary duty to you, the client? No. Thankfully, these types of investment vehicles sold through fee laden products are becoming the exception and not the norm, as more and more wirehouse brokers move to the fee based model where they are fiduciaries. But for a nice analogy of just what it’s like to pitch these fee laden products as a wirehouse broker, we turn to Josh Brown (a former wirehouse broker) of Ritholtz Wealth Management:
I want you to picture a furnace…broiling and roiling with steam and smoke, the air around it bending and wavy in a desert distortion from the heat. That furnace is the hunger for profit at a typical Wall Street wirehouse brokerage firm. Next I want you to picture a massive, self-replenishing mound of coal, spilling over in its abundance, unable to be depleted as more coal is continuously dumped on top. That mound represents customer assets at the wirehouse and the continuous inbound flows of said customer assets.
Finally, I want you to picture a man wearing a leather apron and armed with a massive steel shovel. That man continuously, and without hesitation or pause, is shoveling the coal into the firm’s furnace. Without even looking up at how the last shovel-full has fared once having been tossed into the inferno, the man is already bent into his next thrust, lifting and launching a follow-up pile into the very same fire.
That man represents the brokerage salesforce at the wirehouse. He is shoveling the coal (your money) as quickly as he can to satiate the firm’s need for short-term revenue gains into the furnace. That’s his job no matter how white his smile or what set of caring questions he asks you.
It is only once you understand this analogy that you can understand why Wall Street’s retail brokerage complex is what it is today.
And what if the packagers have the bright idea to blend a few different managed futures funds together into a portfolio. Great idea – and you’ll likely get better performance from that approach; but the typical fund of funds structure adds another layer of fees, with an expense paid to the overall manager of the managers.
Managed Futures Mutual Funds
And finally, there are the newer managed futures mutual funds, which when accessing actual managed futures managers via a fund of funds approach typically do so through a Cayman corporation which purchases swaps on managed futures funds/accounts through a prime broker. The foreign corporation and swaps add another 0.50% to 2% in costs. And the “A share” classes usually have the ability to charge the same upfront fees and “trails” the B/D offered funds have; in order to incentivize the furnace feeding wirehouse brokers.
So the managed futures asset class in a nutshell is, in order of lowest to highest cost: individually managed accounts, privately offered managed futures funds, broker/dealer offered managed futures funds, broker/dealer offered funds of managed futures funds, and broker/dealer offered managed futures mutual funds (excepting those which are replication strategies which keep costs low by not actually accessing the managed future space, instead trying to ‘replicate’ that exposure).
Here’s a quick breakdown for the visually inclined:
So will the investor accessing managed futures via an individually managed account get “fleeced by fees” as Bloomberg suggests? No, there are two fewer layers of fees to contend with. Will the investor accessing managed futures via privately offered funds lose 89% of their gains in fees? No, there is one big layer of fees missing there (the B/D up front and ongoing ‘selling’ fees). Will a managed futures mutual fund investor get eaten up by fees? Yes, if they are in one of the expensive ones and a front end load is charged.
Duh… at least 20% of (gross) gains will go to the manager
Now, even though we agree that some of the packaged products out there are incredibly expensive, that doesn’t mean Bloomberg’s article was particularly accurate.
Let’s start with the ‘share of gains’ argument. The advisors who run Managed Futures funds/programs/accounts/etc. typically charge what a hedge fund charges in terms of fees – a 2% annual management fee, and 20% of new profits. So, it shouldn’t really be front page news that at least 20% of the gains are eaten up by fees. That is the model, and that is what you sign up for.
And let’s talk about time frame here for a second, and the skewed perception that can come from looking at the percentage of fees earned by the manager during periods of poor performance versus times with good performance. A simple excel exercise will show you that a net return of about 3% (gross of 6%) is the breakeven point between more money going to the manager or client under a “2&20” fee structure. At a 1% net return, it’s 70% of the return to the manager, and only 30% to the customer. At a 15% net, those numbers are flipped – with 70% going to the customer.
Bloomberg’s Statistical Deception
There is also a problem with looking at the gross fees and gross returns over any set period without considering the effect of new investors coming into the fund, and time weighted value of early investors investments versus later investors. Consider the following example (AUM = Assets under Management):
2004-2008: $200 million starting AUM, 70% gross return, 50% net return = +$100 million in profits for clients, $40million in fees, $300 million in ending AUM
End of 2008: $700 million in new money comes into the fund, bringing assets to $1 Billion
2009-2013: $1 Billion in starting AUM, -7% gross return, -11% net return = (negative) -$110 million for clients, $40 million in fees.
2003 – 2013 totals: (negative) -$10 million in losses for “clients”, +$80 million in fees
That clearly looks terrible, with the overall fund showing losses of (negative) -$10 million when there were $80 million in fees, but it ignores the fact that there was more money invested during the losing period than there was during the winning period.
And consider a hypothetical investor who was in the fund in 2003 with say $1 million. That investor would have made $500k as of the end of 2008, while paying $200k in fees (a 71/29 split in favor of the investor); and would currently be sitting on total profits of $335k (down $165k from their peak 5 years ago), with the total fees over the 10 years equaling $260k (now down to a 56/43 split in favor of the investor).
This example shows it isn’t as simple as taking the total gross return over the period, and the total amount of fees paid over the period – and deducing that the fees ate up all the returns. That makes for a good headline, but it isn’t accurate when considering the dynamic variables of asset flows into and out of funds and the variable performance of the fund itself. The more accurate headline would be that 89% of gains in futures funds were eaten up by fees and market losses.
Lastly, what does it really matter how much of the gains are eaten up by fees. If that is the only way to access said gains, then it is a fair price for providing those gains. If it isn’t a fair price, capital will find cheaper and better ways to access those returns. And here’s the thing – capitalism is working. The market displays a clear understanding of fees and access to managed futures these days, with the vast majority of assets in structures that have lower fees than cited in the article.
As investment wealth management industry expert Ed Butowsky eloquently put it on a call in response to Bloomberg’s piece:
“The whole world is net, who the hell cares about this percentage of gross argument? Do I care about the fees? Yes, but I care about the net more. Fees only matter in the absence of value.”
Which bring us to transparency and whether ‘futures funds’ investors know how much fees they are paying for their access to the space? Whether this is a “license to steal” as securities lawyer James Cox is quoted as having said in the article? The regulator in charge of reviewing the offering documents of registered managed futures fund operators – the National Futures Association – sent an immediate response to Bloomberg’s editor following the article, saying in part:
The article’s author, David Evans, ignored all of the rules that ensure customers are given correct and current information about the fees they pay and the impact of those fees on their investments.
Commodity pool operators (CPO) are required to provide a detailed disclosure document to potential investors, which includes numerous disclosures regarding the fees and expenses associated with a managed futures investment, including:
- A simple, prominent, easy-to-read break-even analysis that ensures customers are aware of the impact fees and expenses have on the performance of their investments. This disclosure must be expressed in both dollars and as a percentage;
- A complete description of each fee, commission and other expense incurred or anticipated, including a detailed explanation of how the fees are calculated; and
- Performance results net of all fees.”
The article implies investors in managed futures funds are shown gross returns, but then get something much different. And that is just false. Regulations dictate that performance results must be NET of all fees. If the funds Bloomberg researched were marketed without disclosing the net performance or showing the breakeven table, then that is a fraud the CFTC and SEC should investigate immediately. But my guess is the total fees and total amount of profit needed to breakeven each year were clearly labeled in the prospectus as they should be. It’s just that nobody reads that fine print when their coal furnace wirehouse broker is shoveling the thing at them saying how good it is. And come to think of it, wouldn’t it be nice if Bloomberg were held to the same standard of truthful display of information.
Find a Knuckle Ball hitter
So what’s an investor supposed to do? If this managed futures space is a ‘knuckleball’ of a pitch, as Bloomberg portrays – which has confusing terms, many different access points, and different layers of fees throughout. Should they stand at the plate and take a swing, or run the other way for lack of understanding and fear of high fees?
If you run the other way, you might hurt the team (your portfolio) – who needs someone hitting in the non correlated batting slot. But if you blindly step up to the plate and take a swing without knowing how to hit that knuckleball, you might strike out (due to high fees), also hurting your team.
Our humble suggestion would be to find someone to help you see the knuckle ball better… to find a knuckle ball hitter to help your team (portfolio). And indeed, that is the whole reason my company, Attain Capital, and others like it exist. There are people in the futures industry who don’t charge packaging fees or fund of fund fees or front end loads or the like. There are people in the industry who educate and provide knowledge to help investors overcome the information gap between what they pay, and what they should pay. There are knuckleball hitters out there to help your team.
Your article, Mr. Evans, did a real disservice to the hard working, honest folks in the managed futures industry who introduce high net worth individuals, family offices, and fund of funds to hard working, honest commodity trading advisors who trade the accounts of those investors.
The ripoff isn’t being perpetrated by these futures industry brokers, nor by the futures industry trading advisors – who make the bulk of their money from the 20% of profits they deliver to customers. No, the ripoff, if it even exists given the article’s questionable methodology; the ripoff, if there is one, is from the usual suspects… the Wall Street wirehouse furnaces and their coal shoveling brokers.
JEFF MALEC, CAIA
CEO, FOUNDING PARTNER | ATTAIN CAPITAL MANAGEMENT, LLC.
1 E. Wacker Dr., 30th Floor, Chicago, IL 60601
1. Fleeced by a Fool — How Bloomberg Markets Magazine knowingly used deceiving statistics in a hit piece — (Peter Brandt)
2. Bloomberg Takes Another Shot at Alternatives — (Dan Collins)
3. Managed Futures Bloomberged, Part 1 – (John Lothian)