When considering a managed futures investment, always ask for past performances.

- Mark Melin

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October 12, 2007

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Trading can generate great “highs” as well as depressing “lows.” Unfortunately, the hard fact is that the majority of non-professional traders end up loosing money and experiencing the lows in the industry.

That’s the bad news.

The good news is that futures trading is known as a “zero sum game:” for every loser there is a winner somewhere. The question is: Where are the winners, and how do they win?

To start their search, retail traders are increasingly turning to Managed Futures.

Managed Futures is an asset class often used by pension funds, institutions and other professional investors to improve absolute returns and reduce the investor’s risk profile.

Managed Futures “Mutual Fund” of Commodity Industry

To an extent Managed Futures can be compared to a "mutual fund" program for the futures industry because professional money managers invest assets on behalf of their client through a Power of Attorney (POA). The Managed Futures industry is made up of professional money managers known as Commodity Trading Advisors (CTAs). These professional money managers invest client assets on a discretionary basis using global futures and options markets as an investment medium. Unlike a futures broker, Managed Futures program have past track records the investor can consider.

Managed Futures is a “transparent” investment. For a trader, Managed Futures provide an opportunity to see how true professionals trade. As a CTA establishes a trade, it is clearly visible in the investor’s segregated account. As someone who has seen both professional and non-professionals trade, I can tell you I think professionals trade much differently. A non-professional trader would do well to watch professional traders to sharpen their own skills.

So what are Managed Futures and how can this asset class work for a futures trader?

• The CTA: Managed Futures are an asset class where professional money managers / traders with past track records manage client funds through a Power of Attorney (POA). The official term for the money manager is a Commodity Trading Advisor (CTA) and this person generally has a single strategy they follow and execute this strategy for all their clients, much in the same way a mutual fund is traded.
• CTA Compensation: Most CTAs receive their primary compensation from an incentive fee, which is a percentage of the investor's net new profits. If an investor's account is not profitable the CTA does not receive an incentive fee. CTAs may also charge a smaller annual management fee.
• Account Minimums: CTAs each have account minimums that can range from $10,000 to several million. It is not uncommon for the most experienced trading managers with the most consistent performance to have the highest account minimums.
• Industry Regulation: The industry is highly regulated and performance and disclosure documents are reviewed by regulators for accuracy and completeness. When performance is reported by a CTA, it is NET performance, after all fees and expenses. The CTA is independent from Alaron and is responsible for their reporting.
• Investment Strategies : Each CTA often has a very specialized trading strategy that is outlined in their disclosure document, which must be reviewed by the investor before investing. CTA trading strategies are often very sophisticated and rely on a number of different variables to achieve success. Alaron attempts to build multi-advisor CTA portfolios for their clients that are non-corollary to the performance of each other and to the performance of the stock and bond markets. Alaron’s goal is to create an investment vehicle that performs regardless of the market environment. However, no assurance can be made regarding the future performance of any CTA or Managed Futures investment.
• Account Structure: In order to invest in Managed Futures a client must open a segregated account with a properly registered Futures Commission Merchant (FCM) such as Alaron. The segregated account provides the client total transparency and is regulated. Funds in a segregated account cannot be co-mingled with the funds of the FCM or of the CTA, which provides the investor a degree of protection.

The Diversification Effect

In my opinion, the key to success in Managed Futures is building a properly diversified, non-correlated portfolio of strategies.

A balanced, multi-advisor managed futures portfolio can perform more consistently than a single advisor portfolio. In fact, when you consider how the brightest professionals build their portfolios, they often embrace the multi-advisor approach – preferring not to put “all their eggs in one basket.” The goal of a multi-advisor strategy is risk mitigation through portfolio diversification. Ideally as one advisor experiences a drawdown in a negative market environment, a non-correlated investment with a different advisor could be immune from such market conditions and potentially offset any such losses. However, it must be noted that past performance is not indicative of future results and no assurance is being made that any CTA strategy will achieve the desired results.

How to Invest in Managed Futures: Portfolio Approach

So where do you start to build your portfolio? There are hundreds of Commodity Trading Advisors (CTAs) in which an investor can choose. Each trading advisor has a different strategy, risk profile, investment minimums and background.

I like to take a two step process: step one is to understand the client and step two is to make logical recommendations.

Understand Your Risk Reward Profile

Like all investing and trading, the investor should consider their own risk / reward profile, and then select CTA programs accordingly. For simplicity sake, there are three types of profiles you can consider:

A conservative risk profile could result in a portfolio recommendation where past annualized returns in the 15% to 20% range with two to four monthly drawdowns per year.

A moderate risk profile could result in a portfolio recommendation where past annualized returns in the 20% to 35% range and three to five monthly drawdowns per year.

Aggressive risk profiles could have could result in a portfolio recommendation where past annualized returns in the 35% to 80% range and five to seven monthly drawdowns per year.

We also consider an investor’s existing portfolio, their time horizon their concern relative to major event risk. There are managed futures programs that are designed to protect the investor during times of international crisis.

Build a Portfolio

So when building a portfolio for a pension fund or an individual investor, it is best evaluate each trading advisor’s and risk / reward profile and then build a Managed Futures portfolio that by considering items such as the CTA’s standard deviation tendencies, their Sharpe and Sortino ratio, drawdown / recovery times, return distribution and more. We review the CTA’s backgrounds for any NFA or CFTC violations or other questionable activity. From this we develop a “beta” portfolio that is ready for regression testing.  

We run this proposed CTA portfolio through extensive regression analysis using Alpha, Beta and R2 factors. Based on these risk adjusted statistics, we pair what we consider appropriate advisors to build your ideal managed futures portfolio. We then conduct correlation and return / drawdown analysis on the combined CTA portfolio. Our objective is to create a non-corollary grouping of CTAs that have delivered consistent past performance regardless of the economic environment or market condition.

Get Started Today

Is Managed Futures right for you? The best method to consider a managed program is to start the process of building a portfolio recommendation report. To do so, contact Mark Melin today.

The opinions expressed are those of the writer and not necessarily those of Alaron Trading or this publication. There is risk of loss when trading futures and options and investors should only risk capital should be used when opening a trading account. Although the information contained herein is believed to be true, there are no assurances relative to same.

Currently Mr. Melin is Director of the Managed Futures Division at Alaron Trading in Chicago, Illinois. In this capacity he structures managed futures investments for banks, pension funds and high-net worth individuals.

Mark Melin has been involved in the futures industry for over 19 years. Author of two books, including co-author of “The Chicago Board of Trade's Handbook of Futures and Options” (McGraw-Hill 2006), Mr. Melin has a long history working as a consultant to the major futures exchanges in Chicago, operated as a commodity fund manager (CTA), produced the official Managed Futures CD-ROM for the Chicago Board of Trade, and is a columnist for Dow Jones Newswire covering managed futures and alternative investments.

Complimentary Managed Futures CD-ROM

See how professional investors profit from the futures and options markets. With managed futures a professional money manager with a past track record trades your account. Register for a complimentary Managed Futures CD-ROM produced by the Chicago Board of Trade and a portfolio recommendation report with rankings and returns of top managers. Learn more!