Get your Comments in (CTA/CPO Capital Requirements)

In late January 2014, the National Futures Association (“NFA”) announced to its membership they were considering requiring Commodity Pool Operators (CPO’s) and Commodity Trading Advisors (CTA’s) to have minimum net capital requirements similar to what the clearing firms (FCM’s) and Introducing Brokers (IB’s) have:

“…reviewing the current regulatory structure applicable to Commodity Pool Operator (“CPO”) and Commodity Trading Advisor (“CTA”) operations. In particular, NFA is looking at ways to strengthen the regulatory structure governing CPO operations to provide greater protection for customer funds… [and] exploring ways to ensure that CPOs and CTAs have sufficient assets to operate as a going concern.” 

The review of the CTA/CPO regulatory structure also includes possible measures such as the verification of CPO fund balances similar to what is done now for FCM’s, and the possibility of requiring all CPO’s to use third party administrators, or at least have a third party approve all movement of money out of funds.

These are wide ranging possible changes, and every CTA/CPO should consider how these changes might affect their business, especially how their costs might increase, and whether that increase in cost would actually do anything to strengthen customer protections. The deadline for submitting comments is fast approaching, and we urge any and all CPO’s and CTA’s out there to get their comments in before tax day, April 15th. Email the comments to CPOandCTAfeedback@nfa.futures.org with the specific answers and commentary they are looking for here:

We won’t bore you with our full response, which is likely a little too much ‘inside baseball’ for most. But here’s some questions to ponder before writing up your comments (and please do, CPO’s/CTA’s).

1.  Should CTA’s and CPO’s be lumped together in this?  CTA’s do not hold customer funds.

2.  Did capital requirements help at all in the case of Griffin Trading, Refco, Sentinel, MF Global, and PFG?

3. What will it cost you to have a third party administrator for your fund?  Are your investors willing to bear that cost? Do they feel the need for greater protections?

4.  What sort of certification would an admin need to be qualified to perform this role if mandated by NFA? What sort of slippery slope are we headed down if this new requirement create the need for admins to register, a new class of NFA member, new fees, new dues, etc.?

5. How would the NFA verify hard to value assets held by CPO’s which do only nominal futures trading but are required to be registered as a CPO?

6. Is this even a problem?  Are customers of your CTA/CPO asking you about protections, are they worried that your insolvency can cause them problems?

 

 

 

Gross or Net, Winton, and 5 vs 29

We got a comment the other day from an investor who reads our newsletters, touching on the fees involved with managed futures – something we covered in depth last year after Bloomberg Magazine trotted out a misinformed piece on ‘Futures Fund Fees’ (see our response here) – but we hadn’t seen the question of fees posed quite like this before:

“You wrote an article a while back addressing the critiques of Managed Futures Indices.  One area you didn’t address in those articles is the fact that performance numbers are reported gross of fees to those indices.  One of the biggest knocks on this space are the high fees involved, so this almost makes the indices useless, one could argue.”

This investor is somehow under the impression that the various managed futures indices are comprised of manager performance numbers gross of fees (that is, not including the usual 2% annual management and 20% of new profits incentive fee), wherever could he have gotten that idea Bloomberg.

To set the record straight – the main managed futures indices are calculated from manager level performance reported NET of fees. Here’s the language from both Newedge and DJCS:

Newedge Language:

“The index calculates the net daily rate of return for a pool of CTAs selected from the largest managers open to new investment.”

DJCS Language:

 ”Does the Credit Suisse Hedge Fund Index use net or gross data?

Performance data used in the index is net of all fees. “

We’ll even take it a step further and tell you that NFA and CFTC regulations require managed futures managers registered as CTAs and CPOs to report their performance NET of fees, and that the overwhelming majority of managed futures programs which report to the indices are of a size where they use a third party accounting firm or ‘administrator’ to calculate their monthly performance numbers, insuring the correct deduction for accrued fees, any additions and withdrawals, and so on. It’s actually quite hard for a manager to ‘back out’ the fees and arrive at a gross performance number.

Now… what isn’t included in the performance reported to the indices are any additional fee layers which may be added on for a feeder fund or similar such access point to a manager. For example, we recently assisted a client of an Advisor we work with move over to an Attain fund from their investment in something called the Winton Direct fund.  The client assumed, like the reader mentioned above, that the reason he was up just 5% in his “Winton” investment over the past 5 years while Winton’s stated performance was +29% over the same time – was because Winton was reporting their performance gross of fees.

But that isn’t the case… Winton is reporting net of fees just like they’re supposed to and just like everyone else. The 25% difference between the investor’s returns and Winton’s reported returns isn’t due to a gross vs net problem – it was the investor’s access point, coming in through a big broker/dealer which was charging an additional 5% a year for the access. Maybe that’s an acceptable price to pay for access to the ‘Blue Chip’ manager of the managed futures space IF they are returning 25% per year. But when they are doing only 6% per year (NET of their fees), and you are paying 5% extra to access that 6% return – the numbers stop making sense in a hurry.

For a reminder on the various access points to managed futures and the layers of fees involved – here’s our handy chart breaking it down.  This can also show you how the indices can be net of fees, but not net of ALL possible fees. The managed futures indices are typically calculated from performance numbers reported after the first and second access points (the managed accounts and manager offered funds), not after the distributors (B/Ds and mutual fund wholesalers) have gotten their hands on them.

Chart of Fee Structure

Attain Capital’s Semi-Annual CTA Rankings

Now that the last stragglers have gotten their December 2013 numbers in, our latest CTA Rankings are out, which crunches the data on more than 1,000 managed futures programs in our database; whittles that list down to a ranking universe of a little more than 300, and finally arrive at a consolidated list of top ranked programs using Attain’s proprietary ranking algorithm.

Semi-Annual-CTA-Rankingv2

To be calculated in the rankings, a CTA must first qualify with a three year track record, be a registered CTA with the NFA, offer managed accounts, and be a viable business concern. Once the program is qualified for calculation, we take time into consideration, evaluating the metrics across each 1, 3, 5, and 10 year time periods in addition to the full length of the program’s performance.

The end result are rankings based on a CTAs full performance history and both its returns and risk profile –  not just the past 1 or 3 year period and based simply on returns.  The Top 15 overall can be found at the bottom, with the top 5 in different categories preceding it.  Each program has its compound RoR and Max DD since inception listed, as well as the minimum investment for a managed account and date of inception. See our complete rankings here.

Weekend Reads

  • Managed Futures gets call out in Wall Street Journal Column — Voices: Lee Partridge, on Investing in Alternatives – (Wall Street Journal)
  • Hiding Behind Liquidity – Assessing Managed Futures Advisors – (Seeking Alpha)
  • HedgeWorld’s hot 5 data chart(s): managed futures – November 2013 – (Hedge World)
  • I Still Believe in the Futures Industry Model – (John Lothian News)
  • Chart o’ the Day: Messy Democracy Works, US Deficit Plummets – (Reformed Broker)
  • Take Responsibility for Your Stock Losses – (The Big Picture)
  • ETFdb’s 2013 Periodic Table of Returns – (Reformed Broker)
  • QE was really good for rich people – (Bloomberg)

Our post: CTA’s and CPO’s: Vote for Bry and Jaffarian – (Attain’s Managed Futures Blog)
CCC post: CCC Endorses Doug Bry and Ernest Jaffarian for re-election to the NFA Board – (CCC)

Just for Fun:

  • 6 Harsh Truths That Will Make You a Better Person – (Cracked)
  • Bears sign Cutler to 7 years – (Bleacher Report)
  • Bama fan goes crazy on OU student – (Youtube)

CTA’s and CPO’s: Vote for Bry and Jaffarian

One of the few good things to come out of the MF Global and PFG scandals in the futures industry was a renewed interest in good people trying to get involved with the National Futures Association at the Board of Director level – (the other would be the various customer protections since put in place).

Two such good eggs are Doug Bry and Ernest Jaffarian, who were concerned enough about the industry response to MF Global that they petitioned to get placed on the ballot for NFA Director to do something about it (before that, nobody had ever been elected via such petition – since that, James Koutoulas, John Roe, and Attain’s own Jeff Malec were all elected via petition).

Well, they’re now facing a contested election, and we at Attain would like to see them continue the efforts and work that are underway to bring needed reforms to NFA.

Doug and Ernest are owners of dedicated futures firms running against two lawyers from hedge fund giants AQR and Citadel. Don’t get us wrong, the two contenders are extremely well qualified – nearly to the point of being over qualified.  But being a registered CTA and CPO ourselves – We would rather have the people who do 100% futures and whose main business lines are running a CTA and CPO, than the people who do futures as just a part of a global investment company empire.  It also occurs to us that the AQRs and Citadels of the world will make their mark on the futures industry whether in this role or not. AQR’s rep is heavily involved with the Managed Funds Association, for example.

So our recommendation is to go with the guys who’ve been there on the job for the past two years, and who have gained some momentum in the role. Our recommendation is to vote for Douglas Bry and Ernest Jaffarian. But more than anything,  please take the time to vote for your representative to the NFA Board of Directors. You don’t get to complain about the regulations if you don’t vote!

Related:  Commodity Customer Coalition Recommendation for Bry and Jaffarian

Futures Trading is Risky: Myth or Fact

By now, we in the managed futures world are used to the unwarranted assumptions about who we are and what we do. Some individuals see the word “finance,” and think stocks, then 2008 crisis; and therefore bad (which we’ve said over and over again, we have nothing to do with).  Others have an idea of what futures are, but nine times out of ten that idea is ‘way too risky’.

In fact, just the other day, one of the new employees in the office recently had a conversation with their parents about investing in managed futures. As soon as the topic got brought up, a “no way in hell” guard immediately went up, and they responded, “I’ve never even considered it because I’ve always been told how risky it is.”

But the mantra ‘futures trading is risky’ isn’t just something that gets thrown about haphazardly – it’s the rules. Any futures broker registered with the National Futures Association is required to inform those they are prospecting that Futures Trading is indeed risky and that it isn’t suitable for everyone. You’ll see it all over our website as such:

“Derivative transactions, including futures, are complex and carry the risk of substantial losses. They are intended for sophisticated investors only and may not be suitable for everyone.”

So when we read Mike Dever’s Jackass Investing book with its 20 myths about investing, and came across Chapter 12 “Myth: Futures Trading is Risky”, we looked over our shoulders to see if the regulators would coming knocking on our doors. While those of us in the business of professional futures trading, aka Managed Futures, may think from time to time that futures trading is no more risky than the stock market, if done with proper risk management – we’re not about to put it in headlights as the chapter of a book!

But Mr. Dever was (respectfully) so bold… Is he in violation of the NFA rules? Is he downplaying the possibility of loss in futures trading? Is he misleading the public by saying futures trading is risky is a myth? Not in the least, in our opinion. As is often the case, the devil is in the details here:

First, Dever states right from the start that most individual futures traders…lose a lot of money.

“On average, people who trade in and out of mutual funds greatly underperform the return they would receive by leaving  their money in the funds. And the more they trade, the more they lose. Compounding this losing behavior even further, the more leverage they  employ, the greater their loss. And…most individual futures traders trade a  lot and use a lot of leverage. The result: they lose a lot of money.”

Turns out, Dever is making a more nuanced point that futures trading is risky, but futures investing, via managed futures – need not be any more risky than the stock market or other investments. For our own regulatory protection – we’ll still tell you that there is the risk of substantial loss in both futures trading, and futures investing!

Meme of Investing

So the question the book explores isn’t really – is futures trading risky or not, but rather – is managed futures, as an asset class, more or less risky than stocks. To tackle this, Dever presents readers with a sort of blind taste test of two investment returns and risks, and asks which they would rather invest in.

Jackass Investing Figure 34Jackass Investing Figure 35

 

 

 

 

 

 

 

 

(Disclaimer: Past performance is not necessarily indicative of future results)

So what’s your choice? Between 1987, and 2010, chart one had a 9.5% average annual returns, but experiencing losing periods in excess of 20%, and one losing period destroying half of the value. Chart two had the same (or a slightly higher) return, but with less exposure to risk. Who won the taste test, Coke or Pepsi? Turns out the first chart is the S&P 500, while the second chart is the BTOP 50 managed futures index.

But, but, but… there may be a bigger dispersion of returns in the managed futures world versus stocks; there may be survivorship bias; there is a smoothing effect, and so on. Good points and we agree that it may be more telling to look not at the index performance over time, but compare actual managed futures investments and individual stocks. We did just that, selecting the worst 10 performing stocks in the S&P 500 over the past 10 years* to compare to the worst performing large managed futures programs (over $50 million in AUM) over the past 10 years*.  If managed futures wins via the average (the indices) – what does it do in specific cases?

Stocks vs CTAS

(Disclaimer: Past performance is not necessarily indicative of future results)

*To find the 10 worst performing stocks in the S&P 500 over the past decade (a tougher job than it seems), we gathered a list of stocks from a 2011 CNN Money article looking at the worst 20 stocks the past decade, then  found the 10 worst performers from that list over the July 2003 to June 2013 period. The worst managed futures programs represent the worst performing programs which reported to the BarclayHedge datbase as of June 2003 and had over $50 million in assets at that time.  It does not include any programs which came into existence after June 2003 and have since lost more than the amounts listed (when considering those results, the average of the 10 worst performers over the past 10 years, regardless of when they started is -34.39%).

* = A program stopped reporting to BarclayHedge database before 2013

There isn’t much of a comparison… Average the losses of the worst 10 stocks and we’re left with a -90.02% loss, compared to a -11.23% average loss across the worst managed futures programs over the past decade. And those were Fortune 500 companies – the biggest of the big, the blue chips, if you will.

So, yes futures trading is risky. But the point is – stocks are risky too. Very risky if you happen into one of the 10 worst performers.  So are bonds.  So is real estate. Investing is risky…. If there were no risk, it might be called something else (receiving?). So do your own research and ascertain for yourself what the risk looks like in the futures trading you are entertaining, and how that risk stacks up against more traditional investment methods. You may just uncover some myths of your own.

P.S. – Haven’t got your free copy of Jackass Investing yet? The author has agreed to provide a free e-book copy of the book to Attain readers.

P.P.S — Talk about putting money where his mouth is, Dever is the CEO of Brandywine Asset Management, rigorously maintaining and operating their Symphony Program which climbed an eye opening 11.27% in October {Disclaimer: Past performance is not necessarily indicative of future results}. The strength of this program lies in its multi-strategy approach with exposure to nearly all of the exchange traded futures markets that are available to US investors… a Ray Dalio of managed futures of sorts. Differentiators this month (as compared to trend followers) included long Aussie Dollar and South American Rand trades – a result of the basis arbitrage strategies; along with long lean hogs and mini NASDAQ from the fundamental strategy set.  It wasn’t all roses though; Brandywine was on the wrong side of an Orange Juice trade this past month.

 

No, Bloomberg, the managed futures industry is not a scam

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:

Fee Layers for Different Managed Futures Acess Points

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.

2&20 Investor Manager Split

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.”

Transparency

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

See Also:

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)