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Managed futures: Pooled funds vs. individual accounts

From the Issue of Managed Futures Today
Section: Portfolio Building
By: MFT Staff
Available capital, investment time frame, and risk preference will determine the most appropriate managed futures program for your needs.

When investing in managed futures, advisors rightly spend much of their time researching different programs and trading strategies. Another part of the process is considering how the funds will be handled and traded. In the managed futures realm, there are essentially two ways customer funds can be invested — in a individually managed account or in a “commingled” fund or pool.

Tax advantages

Regardless of whether you invest in a commodity pool or an individually managed account, managed futures programs typically benefit (always check to see if a specific program satisfies the tax code criteria) from “60-40” tax treatment: 60% taxed at the maximum long-term rate of 15% and 40% taxed at the higher short-term rate (normal taxable income). In contrast, short-term stock trades are taxed entirely at the higher short-term rate.

Which structure you choose will depend on your investment objective and time frame, the amount of direct account control and transparency you desire, risk tolerance, and — most importantly — how much capital you have to invest. The largest investors have the most leverage to open individually managed accounts and negotiate specific terms.


Commodity pools
A “commodity pool” is similar to an equity mutual fund: Funds from multiple investors are combined in a single brokerage account, which the fund manager trades as a single entity. Futures fund managers typically establish commodity pools as limited liability corporations (LLCs), which means an investor cannot lose more than the initial investment. Commodity pools are more common than individual accounts in the managed futures industry because pools are the most efficient structure for fund managers.

Brian Walls, co-head of research at Newedge’s (www.newedge.com) prime brokerage group, says such funds are “usually the cheapest way for a manager to operate.” For some investors with relatively limited capital, a pool can offer access to a more diversified portfolio of futures markets or strategy types than they might be able to afford individually. For example, an investor with $50,000 might be able to participate in a commodity pool consisting of many millions of dollars, which would allow the fund manager diversify across a wide range of markets and/or trading systems. That same manager would not be able to diversify to the same degree trading the $50,000 in an individual account.

When you invest in a pool, you give up some of the transparency and liquidity of a separately managed account. A Commodity Pool Operator (CPO) typically publishes the pool’s net asset value (NAV) every month or sometimes every two weeks. In terms of liquidity, managers commonly allow investors to withdraw capital each month with five days notice.

Overall, however, pool restrictions are relatively limited. “I’ve rarely seen lockups, gates, or redemption penalties in pools,” says Adam Rochlin, managing director at futures brokerage MF Global. “It’s a very investor-friendly structure.”

Check list
A few things to consider when selecting a managed futures program and account type:

How much capital are you investing?
More capital means more options, both in terms of account type and market/strategy diversification.

What kind of liquidity do I need?
Pools are less liquid than individual accounts and are more likely than individual accounts to have restrictions on redemptions, etc.

What are the fees?
Standard managed futures fees are “2 and 20” —
2% of assets under management and 20% of profits. The more individual attention you receive, the higher your costs will likely be. Funds of funds typically have additional fees because of the extra management layer, but they can also offer more diversification.

Risk and liability
While risk in a commodity pool is typically limited to the amount invested, holders of individual managed futures accounts are often liable for risk beyond the initial investment.

Are customer funds segregated?
Although this is standard practice, always check to see if customer funds are segregated from firm (i.e., the brokerage holding the trading account) funds. In the event of financial problems at the brokerage, segregated funds are protected from being used to satisfy the firm’s financial obligations.


Funds of funds
Similar to a commodity pool is a managed futures fund-of-funds: The manager raises investor capital and distributes the pooled funds among multiple CTAs to diversify among different strategy types and market specializations. While futures funds of funds tend to charge higher fees (and often have higher minimum investments), they can also offer more diversification.


Individually managed accounts
Futures investors with more capital at their disposal often opt for individually managed accounts. Although commodity funds passed through the 2008 financial crisis largely unscathed — in fact, managed futures as a whole had one of their best years on record (see “30 years of managed futures,” and “Managed futures vs. stocks,” Managed Futures Today, May 2010) — some investment advisors are drawn to the higher transparency and flexibility of separately accounts for their clients.

With an individual managed account, the money stays in your name rather than being pooled in an account with other investors’ funds. The investor or investment advisor opens an account at a futures brokerage, giving the fund manager (through a power of attorney agreement) the authority to trade the account. You can typically monitor trades and positions in real-time, as well as terminate a trading agreement at anytime.

As a result, an individually managed account is a more “liquid” investment than a pool. “You own the account, so if you ask the trader to go to cash — typically with 24 hours notice — they would be able to do it by the end of trading day,” Rochlin says.

While minimum investments for commodity pools can range from as little as $5,000 to $50,000, the threshold for individual accounts is typically much higher — for example, $500,000 to $1 million or more. Asset size matters because some CTAs often need at least $1 or $5 million to accurately trade multi-market or multi-system strategies. It’s important that fund managers avoid “performance-tracking” risk by ensuring investors are properly exposed to all markets.

“If [the manager] covers 25 different products and markets, and they can only get you into 15, there will be a fundamental disconnect between what they’ve done [in the past vs. your performance],” Rochlin explains.

A downside to individually managed accounts is they can cost more and require more supervision than pooled investments. Ryan Duncan, co-head of research at Newedge’s (www.newedge.com) prime brokerage group, notes that “while you have complete control, you also have complete responsibility for all the minutia.” Account holders have more legal liability than pool investors because they can face margin calls or potentially lose more than the account currently holds.

Finally, not all commodity trading advisors (CTAs) offer individual managed accounts.


Driving a hybrid
Several firms, including AlphaMetrix, Lyxor, CASAM, and Deutsche Bank, recently began offering hybrid products that combine the transparency and protection of individual accounts with the efficiency of pooled funds.

These firms typically open one account with a fund manager and allow multiple clients to invest while keeping individual assets in separate accounts at FCMs. This compromise boosts investors’ choice, transparency, and control, while funneling assets to fund managers who aren’t required to open separate accounts for each investor.