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Following ourlast post about Separate Managed Accounts, Futures Funds are another way to access the CTA universe. While Foremost Capital exclusively deals with Separate Managed Accounts, futures funds are worth explaining because they are so prevalent.
Before we dive in, there are two terms to define. According to the NFA, aCommodity Poolis an enterprise in which funds contributed by a number of persons are combined for the purpose of trading futures or to invest in another commodity pool. ACommodity Pool Operator (CPO) is an individual or organization that operates a commodity pool and solicits funds for the pool.[i]
Any type of fund essentially involves some type of legal entity (partnership, LLC, etc.) used to pool money together for the purpose of investing. As it relates to Managed Futures funds, there are a few different types that vary in complexity.
The simplest setup is a generic private commodity pool. Investors pool their money in order for the purpose of trading. This could be an investment club or a private hedging strategy for multiple dealers in a commodity. This setup is also used by CTAs who dont accept SMAs but instead just want to manage one pool of money, i.e., the pools account. It is often the case that the CPO is also the CTA but its not required.
If you add another layer to the basic commodity pool setup, then youve got a Fund of Funds. If you have experience in the hedge fund world, you may be familiar with this model. As it relates to Managed Futures, a FoF is simply a commodity pool that invests in other commodity pools.
Investopedia wrote a good article about FoFas it relates to hedge funds, but the same principles apply to Managed Futures. Yes, there is an added layer of complexity and fees, but this setup may provide access to opportunities he or she may not have otherwise.
Managed Futures hit the mainstream with the genesis of Managed Futures Mutual Funds and ETFs products more familiar to investment advisors. These vehicles must follow the rules in the Investment Act of 1940, which makes them far more accessible, but also provides problems for futures investing, which we will explain later. Like other mutual funds and ETFs, these funds have a ticker symbol; you can easily access their information from almost any stock trading platform/website.
The biggest CTAs and managed futures firms out there have led the way in creating these products. A quicksearch on Morningstarwill give you a long list of managed futures funds and their share classes.
Because of their prevalence, its worth mentioning two other types of futures funds. Across the pond, our European friends use their version of a mutual fund called a UCITS or Undertakings for Collective Investment in Transferable Securities to bring managed futures strategies to the public.[ii]The largest CTAs in the space like Winton or AQR maintain both domestic mutual funds and UCITS access points.
Another important fund setup is a Managed Futures platform likeRJ OasisorKettera Strategies. A platform attempts to marry the best features of managed accounts (like transparency, investment choice, and liquidity) with those of a fund (no debit risk, collective buying power).
Because the Managed Futures Mutual Fund is the most accessible product out there, it makes sense to take a look under the hood. There are some important elements that distinguish a mutual fund from a private pool (not to mention an SMA), which create hidden limitations. A Funds prospectus, while accurate, may not always be easy to understand.
Buying into a mutual fund means you own a share of a Registered Investment Company. The SEC and specifically the Investment Act of 1940 regulate mutual funds. If a mutual fund wanted to focus on Managed Futures, it needs to adhere to different regulations than, for example, a private commodity pool that is regulated by the CFTC and the Commodity Exchange Act.
One of these limitations is the amount a mutual fund can invest directly in futures and other derivatives, the very thing a CTA needs to do. To accomplish their goal, Managed Futures Mutual Funds will use a Controlled Foreign Corporation (CFC), often located in the Cayman Islands, to do the investing on its behalf. Profit (and loss) flow back from the CFC to the mutual fund. Pretty quickly you can see there is an intricate web of ownership and cash flow in order to gain access to a CTA via a mutual fund. These added layers of companies and service providers all have a purpose but come at a cost. (Guess who ultimately pays that cost?)
Furthermore, the mutual fund is limited to investing only 25% of its assets into the CFC.[iv]In simple terms, this means that $1 invested in a Managed Futures mutual fund does NOT have $1 of direct exposure to Managed Futures. It may be more than 25% through leverage at the CFC level, but youd only know about this by reading the fine print.
Even if a futures fund does not fall under 40 act rules or utilize a CFC for investing, there may be various types of other securities held in the fund. While its likely the fund is using these securities as an income-producing substitute for cash, they have unique risks of their own. One example is Steben & Cos Futures Portfolio Fund, LP. They hold various types of domestic and foreign corporate debt and even small amounts of asset-backed securities on things like receivables for car loans and student debt.[v]
Much more can be said, but we wanted to point out some of the underlying complexity and hidden elements that specifically pertain to certain types of Managed Futures funds.
Managed Futures are not for everyone, but its important to know all your options as you consider alternative investments. Here is a very brief table comparing different features of futures funds and SMAs.
There can be very good reasons to invest in a Managed Futures fund like lower investment requirements and limited liability. But you can see why we are partial to managed accounts for reasons like increased transparency, cash efficiency, and liquidity. As always, we invite you to contact us for more information. If the devil is in the details, we want to shine the light of clarity. There is no reason for you to learn alone. Give us a call!
[ii] Investopedia has a helpful video about how the European Union uses its UCITS vehicle.
[iii] For more information on public vs private fund regulations see: P75_10439
[iv] Introduction and Overview of 40 Act Liquid Alternative Funds. Citi Prime Finance, July 2013, via Managed Funds Association.
[v] Steben & Company Futures Portfolio Fund, L.P. 10-Q Filing, Q2 2017.
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