The Murk Of Managed Futures Funds

(Dow Jones) There's an emerging class of mutual funds that can be described with scary words like opaque, volatile and-here come the goose bumps-leverage.

They go by the name "managed futures funds," and to many investors and financial advisers they continue to sound unseemly and appear too complicated.

Other investors, however, are pouring money into managed futures-to the tune of billions last year alone. They have their reasons: impressive returns through the financial crisis, lower minimum investments and returns that almost never mimic the stock markets'.

Managed futures are becoming a popular choice for assets that might normally go to commodities or other alternative investments. As they move steadily toward the mainstream, still-unknowing investors and financial advisors need to understand how funds that use them disclose leverage-and how that leverage differs from, say, the leverage of a teetering Wall Street investment bank.

"The word leverage is really kind of a vague term," said Jeremiah H. Chafkin, co-manager of the Natixis ASG Managed Futures Strategy Fund. "People use it, but it's not clear whether they're referring to bank borrowing," as with some leveraged hedge funds, "or margin-to-equity ratios," which are the gauge for managed futures funds.

The managed futures industry boasts a noteworthy line-up of investors, including a revered professor, a well-known Goldman Sachs alum and even the owner of a prominent professional baseball team. But with the bulk of futures-focused mutual funds still in their infancy, some say the transparency standards are thin. In fact, it can take a surprising amount of work for investors to know how their money's currently invested.

Funds that invest in managed futures typically hold cash-or the fund's assets-against a portfolio of contracts, known as futures, tied to the movement of things like interest rates or the price of corn. Some hedge funds carry a portfolio with a notional value 15 or more times larger than the fund's assets. For mutual funds, which are more regulated, the number is around six, says Nadia Papagiannis of Morningstar. They have "plenty of cash" to absorb losses, she says.

Although managers like Chafkin point out they can dial up or dial down a fund's risk and volatility to fit the economic environment-an ability they notably demonstrated during the financial crisis-mutual fund investors must have some trust. There are skimpy requirements for mutual funds to report the current risk they're taking, at least as compared to many private futures managers. And understanding the data that's available requires both an expert and a calculator.

One gauge of risk is a manager's margin-to-equity ratio. The measure can vary widely from manager to manager, and even quarter to quarter.

The AQR Managed Futures Strategy Fund (AQMIX), managed by former Goldman hedge fund manager Cliff Asness, typically carries a ratio under 10%, a fund spokesman said, but was recently closer to 13%. The Natixis fund, which is co-managed by Andrew Lo, a revered scholar at the Massachusetts Institute of Technology, is allowed to use a ration as high as 25%, but has been operating considerably below that level, a spokeswoman said.

Private managers vary more widely in the risk they take. One strategy tied to John W. Henry & Co., owned by the Boston Red Sox owner John Henry, targets a ratio between 9% and 17%, a company spokesman said.

Campbell & Co., another manager, operates a strategy that uses a ratio closer to 30%, according to an estimate by Mark Melin, author of "High-Performance Managed Futures." Melin's estimates show that other managers take even more risk. A Campbell spokeswoman said the company wouldn't respond to Melin's estimate.

"I would like to see clear disclosure of risk" for mutual fund investors, Melin said.

In the meantime, he's teaching a new class on managed futures at Northwestern University where motivated advisers and investors can learn to do their own math.