Managed Futures

Managed Futures FAQ

An Introduction to Managed Futures

Modern Portfolio Theory developed by Professor Harry Markowitz, for which he was awarded the Nobel Prize, states that if an investor wishes to increase the performance and reduce the risk and volatility in an overall investment portfolio, that investor should combine non-correlated asset classes with one another.

At Heritage West Financial, Inc. we strongly believe that one of the most effective ways to accomplish these goals is through the use of professionally managed futures. Managed futures have been shown to provide the investor greater diversification while at the same time reducing overall risk and volatility. An investment in a professionally traded managed futures account can also bring exposure to important international markets that otherwise would be unavailable in traditional investments. The case for diversification of one’s investment portfolio with managed futures is extremely strong when considering the litany of evidence available.

After extensive research, we have selected several CTAs based on our strict criteria to offer our clients. Each of the CTAs has a different background, trading style, track record, and compensation structure. Should you have interest in our managed accounts we would be happy to send further information to you. Heritage West will work with you to help you find a managed futures program that suits your financial objectives and risk parameters.

Benefits of managed futures:

• Reduced Portfolio Volatility Risk: The primary benefit of adding a managed futures component to a diversified investment portfolio is that it may decrease portfolio volatility risk. This risk-reduction contribution to the portfolio is possible because of the low to slightly negative correlation of managed futures with equities and bonds. One of the key tenets of Modern Portfolio Theory, as developed by the Nobel Prize economist Dr. Harry M. Markowitz, is that more efficient investment portfolios can be created by diversifying among asset categories with low to negative correlations.
  
  
• Potential For Enhanced Portfolio Returns: While managed futures can decrease portfolio risk, they can also simultaneously enhance overall portfolio performance. This is substantiated by an extensive bank of academic research, beginning with the landmark study of Dr. John Lintner of Harvard University, in which he wrote that "the combined portfolios of stocks (or stocks and bonds) after including judicious investments in leveraged managed futures accounts show substantially less risk at every possible level of expected return than portfolios of stocks (or stocks and bonds) alone.” Viewed as an independent investment, managed futures have compared favorably with U.S. stocks and bonds over the last decade.
  
  
• Ability To Profit In Any Economic Environment: Managed futures trading advisors can take advantage of price trends. They can buy futures positions in anticipation of a rising market or sell futures positions if they anticipate a falling market. For example, during periods of hyperinflation, hard commodities such as gold, silver, oil, grains, and livestock tend to do well, as do the major world currencies. During deflationary times, futures provide an opportunity to profit by selling into a declining market with the expectation of buying, or closing out the position, at a lower price. Trading advisors can even use strategies employing options on futures contracts that allow for profit potential in flat or neutral markets.
  
  
• Ease Of Global Diversification: The establishment of global futures exchanges and the accompanying increase in actively traded contract offerings have allowed trading advisors to diversify their portfolios by geography as well as by product. For example, managed futures can participate in at least 150 different markets worldwide, including stock indexes, financial instruments, agricultural and tropical products, precious and nonferrous metals, currencies, and energy products. Trading advisors thus have ample opportunity for profit potential and risk reduction among a broad array of non-correlated markets.
   
  Professional management:
  The benefits that professional management offers with managed futures are similar to those experienced with mutual funds and investment advisors. These include:
  
  
• Full-time dedication to the markets
  
  
• A disciplined trading approach
  
  
• Money management techniques that seek to control losses and protect profits
  
  
• Strategies that attempt to balance risk and reward
  

Heritage West’s criteria for selecting CTAs:

• Performance: All CTAs must update and submit to the National Futures Association (NFA) a current spreadsheet of data listing a composite grouping of all the accounts under their control. This "track record" must be included in the CTA’s Disclosure Document and presented to any customer before an account can be opened. This is what separates the CTA from the solicitor who makes the statement that he can trade the markets successfully or that his clientele have been successful in the futures market. An audited track record is a compilation of the total funds under the control of the trader and the total profit or loss amounts and percentages.
  
  
• Consistency: We select CTAs based on the money management skills and trading style that they employed in the past to achieve consistent returns. We are more interested in seeing a pattern of growth in the total return and the total funds under the trader's management than finding someone who had a good year or two. Over the years, "hot" CTAs have come and gone. We are looking and will continue to look for stable, profitable, and consistent professional traders.
  
  
• Minimum Account Size: According to industry sources, the best CTAs have $100,000,000 or more under their management. They may not wish to bother with accounts of less than a million dollars. The CTAs with the worst track records will take anything that they can get. We look for traders that have a track record at least 2-5 years long that is profitable and has a program that could be advantageous for an investor with $40,000 to $500,000 of risk capital.
  

Note: Before detailed descriptions of a CTA or any discussion of their background or their track record is allowed you must be given the opportunity to examine the entire Disclosure Document of that CTA. This is a requirement of the National Futures Association and we must adhere to their regulations. Therefore we strongly encourage you to examine the Disclosure Document of any CTA that interests you. Should you have any questions, please contact us

Studies Supporting Managed Futures:

Independent research presents a well-supported case for diversifying an investment portfolio with managed futures.

The impact of portfolio diversification

One of the most attractive features of managed futures is the ability to add diversification to an overall investment portfolio. This ability has been documented in several studies. According to one such study conducted by the Chicago Mercantile Exchange, “Portfolios with as much as 20% of assets in managed futures yielded up to 50% more than a portfolio of stocks and bonds alone.”

Another Chicago Board of Trade study shows a portfolio with the greatest returns and least risk comprised 45% stocks, 35% bonds, and 20% managed futures, while a portfolio exhibiting the greatest risk and least returns comprised of 55% stocks, 45% bonds, and 0% managed futures.

Source: Chart derived from the statistics presented in “A Question & Answer Report - Managed Futures Accounts,
*Chicago Mercantile Exchange, 1993.

Potential Impact Of Managed futures On The Traditional Portfolio Jan. 1980 - May 2003

This graph from a study published by the Chicago Board of Trade in the 2004 edition of “Portfolio Diversification Opportunities” shows that a portfolio without managed futures under performs and is more risky than a portfolio that includes managed futures. The portfolio that exhibited the highest returns and least volatility comprised 41% Stocks, 41% bonds, and 18% managed futures.

Performance Of Selected Asset Classes Including Managed futures

Managed futures have compared favorably with U.S. stocks and bonds, as well as international stocks, over the last decade (see Table 1). In addition, managed futures outperformed U.S. stocks and international stocks during the worst peak-to-valley drawdowns of the S&P 500, the NASDAQ, and the MSCI Europe, Australia, and Far East (EAFE) Index (see Table 2). These graphs are from a study published by the Chicago Board of Trade in the 2004 edition of “Portfolio Diversification Opportunities.”

Performance of Selected Asset Classes 1993-2002 (Table 1)		Worst Case Declines - & How Managed Futures Performed (Table 2)

We hope that you now possess a better understanding of managed futures and all of the benefits that they offer. Informed investors owe it to themselves to investigate managed futures. Many prominent analysts believe we are presently in a long-term bear market in stocks that could last for many years to come. By adding managed futures, which are non-correlated to stocks, to your portfolio, you can potentially capitalize on a lackluster or bear stock market. To find out about our recommended CTAs, please call or click on the link below and we will give you a call to discuss an appropriate strategy based on your financial profile. You can feel confident that we have chosen CTAs based on performance, prudent money management, and sound reputation. We look forward to hearing from you!

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MANAGED FUTURES FAQ   

For the individual or the institutional investor who is simultaneously performance oriented and risk conscious, the key question 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 managed futures account. By providing plain language answers to plain language questions, the information that follows can be helpful in deciding whether a managed futures account can help achieve specific investment goals in today’s volatile and increasingly challenging investment markets.

TABLE OF CONTENTS

1. What is a managed futures account?

A professionally managed futures Account is like any other brokerage account established to trade futures except that you give permission to make all trading decisions on your behalf through a revocable power of attorney to a Commodity Trading Advisor (CTA). In this sense, the advisor is the account “manager.” The advisor’s compensation is normally a management fee plus an incentive fee contingent on profitability. top

2. What types of investors utilize managed futures accounts?

It has 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. The total amount of capital in managed futures programs is estimated to exceed $50 billion. top

3. What has been responsible for the growth in managed futures?

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.

A number of studies indicate that a portfolio that includes managed futures can yield 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, or even reduced risk.

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. top

4. 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 those portfolios “have substantially less risk at every possible level of return than portfolios of stocks, or stocks and bonds.” Research studies demonstrate that managed futures have a low or negative correlation to the stock and bond markets. Additionally, the futures markets provide profit opportunities on a highly leveraged basis in either bull or bear markets in the financial and commodity markets.

For the period of January 1, 1980, to December 31, 1998, data show that managed futures investments (measured by the Barclay CTA Index) had a compound annual return of about 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% return on bonds. Moreover, during a similar period (January 1, 1980, to December 31, 1997), analysis showed that a portfolio that comprised some managed futures had similar profitability with far less risk. top

5. Why can investment portfolio performance be improved by including managed futures?

There are several reasons, 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 worst two 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 twelve months and best twelve months and found that managed futures posted gains during both periods. top

6. Is a managed futures account appropriate as a short-term investment?

No. Futures markets, like most markets, tend to be cyclical. In addition, even an advisor who is highly successful over the course of a year will probably experience some months in which losses occur. 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 3 years. This allows the account to recover from any temporary losses in equity and to benefit from longer-term returns. top

7. Does having a managed futures account lessen the risk of futures trading?

There is no method of futures trading that doesn’t involve risk. The same leverage and price movements that can produce trading profits can produce trading losses. Any loss that can occur when an individual directs his own account also can occur in a professionally managed futures account. However, one of the things that you should definitely look for in a trading advisor is a long-term demonstrated ability to manage risk. top

8. How does the performance of managed futures accounts compare with that of self-directed accounts?

Some individual investors, those who have experience, time, access to information, and necessary temperament, are highly successful in directing their own futures trading. The record suggests that only a small percentage of “do-it-yourself” futures traders possess these requisites for success. Studies indicate that somewhere between 65 and 90 percent 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. top

9. Are there other reasons why managed futures 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 liquidate positions. It requires the development and implementation of carefully considered trading strategies, a trading plan, and a trading system. 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 advisors to manage their futures trading investments. For most individual investors, the advantages can be even greater. top

10. Don’t trading advisors differ from one another in their investment results?

Definitely. In any given year, some will realize impressive profits and others will incur losses. Still others will be anywhere in between. The success of your managed account will depend on the success of the advisor you select. top

11. How important is an advisor’s past trading performance?

As advisors and prospectuses are required to state, past performance is no guarantee of future results. An advisor who has performed well in the past may perform poorly in the future. And it is possible that someone who has performed poorly may begin to perform well. This notwithstanding, in any endeavor some individuals are obviously better at what they do than others and a track record is at least an indication of past performance. In addition, a track record can provide other valuable information about an advisor’s experience, approach to trading, and amount of money under management. You’ll also want to note whether performance data included in the disclosure document refers to actual trading results or to “hypothetical” or “simulated” results. top

12. What should be considered in examining an advisor’s track record?

Start by considering the length of the record. Sprinters aren’t necessarily successful distance runners. Sensational performance in a short time span may reflect little more than extraordinarily good luck. Or, of more concern, it may reflect someone who takes greater risks than you may be comfortable with over the long haul. Or it could reflect specialization in markets that, in a given period, were especially active. Track records can be much more meaningful when you examine a longer record. This provides more information about how an advisor has performed over the landscape of continuously changing market scenarios. An advisor’s performance in less than spectacular years may be an important indicator of risk management skills. top

13. Which futures markets would I be trading in with a managed account?

Your trading advisor will determine this and in all likelihood it will be different markets at different times. Futures contracts are available in the following sectors: top

14. How do trading 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. If you have a preference for a particular approach, this should be taken into account. Another difference is whether the advisor employs a fundamental or technical trading system. Fundamental means that trading decisions are based principally on supply and demand, and “technical” means 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. Moreover, the fundamental-technical distinction has broken down somewhat as fundamental advisors frequently employ computerized tools to pinpoint the timing of their trading decisions. top

15. Where will my money be held when I establish a managed account?

Your money is held in a Customer Segregated Account at our clearing firm, REFCO, LLC, the world’s largest non-bank Futures Commission Merchant with more than $4 billion in global equity. While the trading advisor will direct trading for the account, REFCO performs all other account functions. top

16. Who regulates Commodity Trading Advisors?

Commodity Trading Advisors are regulated by the 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 be registered with the CFTC and those who manage customer accounts must be members of the NFA. Advisors’ Disclosure Documents are required to be submitted to the CFTC for review in advance of distribution to prospective investors. On an ongoing basis, the NFA audits Disclosure Documents (particularly performance information), promotional materials, and trading activities. Violations of CFTC or NFA rules can result in a loss of trading privileges and other penalties. top

17. How do I monitor the status of my account?

Heritage West will provide the same timely reports you'd receive if you were directing your own account. These are available a few different ways. First, a complete listing of all the activity in your account, including your balance, can be viewed on our website 24 hours a day. Second, you may call us at 800-263-3004 to obtain an up-to-date status of your account. Finally, you are sent a P&S (purchase and sale) statement, which shows dates, prices, and net profits or losses for all trade activity, as well as your account balance. In addition, you will receive a monthly summary of all transactions showing their results. top

18. What mistakes do investors sometimes make regarding managed futures?

There are three basic ones. First, because of the risk, futures trading in any form may not be appropriate for a given person, even if a managed account seems more attractive than do-it-yourself trading. Unless you're comfortable with the risk level and feel it's appropriate for you, it would be prudent not to invest at all. Second, an investor might select an advisor based solely on whether the advisor is currently hot. A prudent investor will select a CTA based on the money management skills and a trading style that has been employed in the past to achieve consistent returns. Lastly, investors engage in "account jumping," or prematurely closing accounts out of panic and fear when experiencing a period of flat returns or drawdowns. By doing this, the investor loses the opportunity to recover from those temporary losses in equity and benefit from longer-term returns. top

19.  What are the costs, and how do trading advisors get paid?

There are basically three types of charges involved when a managed account is handled by a CTA. A management fee usually between 1-4% of the value of your account is charged for the overseeing of the trading in your account. Most CTAs charge an incentive fee which typically runs from 15% - 30% of the cumulative net trading profits calculated at the end of each quarter. The net trading profits are the combined total of profits and losses from trading. It should be noted that often a CTA will negotiate a lower or no management fee in exchange for a higher incentive fee. We particularly like these arrangements because they can mean that the person making the trading decisions on your behalf makes no money until you do. Brokerage commissions of $10-25 per side plus a few dollars in fees are also charged. top

20. Is there a minimum investment to establish an account?

Yes, but different managed account programs have different minimums. At the least, it will be an amount the advisor considers adequate to achieve account diversification. Minimum account size also may be affected by whether the managed account program is designed principally to serve individual investors or institutional clients. According to industry sources, the best CTAs have $100,000,000 or more under their management. They may not wish to bother with accounts of less than a million dollars. The CTAs with the worst track records will take anything that they can get. We look for traders who have a profitable track record at least 2-5 years long and who have a program that could be advantageous for an investor with $30,000 to $500,000 of risk capital. top

21. Are there any restrictions in withdrawing funds from my account?

Managed accounts offer a high degree of liquidity. The only restriction is usually that you do not make withdrawals below the minimum required investment. You are free to withdraw all funds after liquidation of any open positions. This can be done at any time you choose unless the account agreement stipulates otherwise. Similarly, if there are profits in the account, you are free to withdraw them or leave the money available for reinvestment. You have complete control over your account and can deposit additional funds, withdraw funds, or stop trading any time. top

22. What is a Commidity Trading Advisor (CTA)?

CTAs are federally licensed and registered, professional money managers who manage investors’ assets in the futures markets, just as a stock mutual fund manager would manage assets in the stock market. CTAs are required by the federal government to submit a Disclosure Document that outlines who they are, states the fees and expenses charged to accounts, and reveals their performance track record. Numerous studies have shown professional Commodity Trading Advisors experience an impressively higher success rate than the individual “do-it-yourself” trader. Through CTA-managed accounts, investors can access emerging profit opportunities in important international markets unavailable in traditional investment portfolios. top

23. How much money should I invest in managed futures and how do I open an account?

We recommend that the amount of money you invest be based on your own financial goals and risk tolerance. This should usually be approximately 5% to 20% of your overall portfolio. Only risk capital should be used in managed futures or any speculative investment. Before opening an account you must be supplied with a copy of the CTA's Disclosure Document. Read it carefully and go over any questions you have with your Heritage West broker before you invest. After your questions have been answered and you feel this type of investing is appropriate for you, we will help you to complete the CTA management agreement and REFCO Customer Agreement forms which you will need to return to our offices for processing. top

24. Why would I need managed futures if I were already trading futures?

Trading your own account limits your returns to your own ability and system. By employing CTAs who have a good performance record, you are developing a diversified portfolio of your own. Thus you can gain even greater benefits from having futures in your portfolio. top

25. Can I invest a portion of my retirement portfolio in managed futures?

Absolutely. Managed futures are ideal for the long-term profile of retirement plans. Investors can choose those products that offer a level of volatility appropriate to their retirement objectives. Managed futures, therefore, make extraordinarily beneficial long-term additions to an IRA by diversifying among asset categories with low to negative correlation. top

26. Are managed futures riskier than stocks?

On a level playing field, managed futures are no riskier than stocks. However, it is important to understand that the use of leverage available in futures creates the potential for unlimited risk. The prudent use of this leverage is one of the most important money management rules in futures trading. Stocks and futures are both investment vehicles employed by money managers as a means of making profits. Some managers succeed where others falter. Remember, it’s not the investment vehicle that makes or loses money, but rather the money manager’s skills and abilities that will determine results. In his June 2002 academic study, “Benefits of Managed futures,” Thomas Schneeweis, Professor of Finance, at the University of Massachusetts states:

“Managed futures are not more risky than traditional equity investment. Investment in a single commodity trading advisor is shown to have risks and returns, which are similar to investment in a single equity. Moreover, a portfolio of commodity trading advisors is also shown to have risks and returns which are similar to traditional equity portfolio investments.” top

27. Are there any tax benefits to investing in managed futures?

According to the Tax Act of 1981, short-term profits (held for less than one year) in commodities are treated as 60% long term and 40% short term. On the other hand, short-term trading profits in stocks are treated as 100% short term. For investors in higher tax brackets, this tax treatment can mean saving as much as 30% on taxes on short-term gains on commodities versus stocks! top

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Past performance is not indicative of future results. 
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