Unlike commodities traders, managers of CTAs don't sit down at the computer and decide what to buy and sell that day. Instead, they rely on model-driven analysis and computer trading executed according to algorithms. Designed by physicists, actuaries and economists, these algorithms determine the most advantageous times to sell contracts before their terms expire. By the time a CTA invests in a contract, these algorithms have determined conditional trading instructions that include exit strategies.
Tactically, this process could be likened to the arcade game of Whac-A-Mole, in which the object is to smash the mole's head with a mallet each time it pops up. The more times the player hits the mole before it disappears, the higher the score. The same goes for the algorithms: The more times they correctly identify advantageous times to buy or sell, the higher the profit.
Humans can defeat the mole, but they're no match for computers that run 1,000 trillion calculations per second, so CTAs with substantial resources have a distinct advantage.
Though high-net-worth clients sign contracts with specialty advisors, fiduciary duties of planners, wealth managers and other registered investment advisors require extensive due diligence. In vetting specialty firms, client-facing advisors should ensure that they:
Are members of the National Futures Association, which holds its members to standards and addresses risk-related issues affecting individual investors.
Use CTAs that have a substantial trading volume. Those with extremely low trading volumes aren't required to register with the Commodity Futures Trading Commission, which administers the Commodity Exchange Act of 1936.
Do business only with CTAs who use third parties to custody client assets and separate third parties to handle administration. Such checks and balances are not only essential to protect client assets, but also to increase the comfort level of high-net-worth clients who are understandably skittish in this post-Madoff era.
Robert J. Lindner, CFP, is founder of Lindner Capital Advisors (www.lcaus.com), an advisory firm in Marietta, Georgia that integrates a managed futures component into the portfolios it manages for clients of financial planners and wealth managers. Listen to a podcast interview with Bob Lindner on managed futures and contemporary portfolio management.