Arguably, the big disadvantage of managed futures is that they're structured in a way that makes them largely inaccessible for all but the very wealthy. A good portion of CTAs (if not a majority) only offer their services to institutional customers. Qualified eligible persons (QEPs -- i.e. market professionals) or accredited investors -- individuals having portfolios valued at over $2 million and incomes in excess of $200,000 per year also are eligible. Regulations restrict those who serve to this restricted audience from virtually any communication with non-QEP individuals. As a consequence there's a huge void in readily accessible information about available CTA services to the less-than-high-net-worth investors.
Besides the managed futures account, an alternative vehicle for non-qualifying investors is a commodity pool. A commodity pool is structured as a limited partnership that functions much like a mutual fund. The commodity pool operator (CPO) offers the services of one or more CTAs to a set of limited partners, where the required amount to participate tends to be smaller than that required for a managed account. Pool requirements vary widely, but a minimum investment of, say, $25,000 seemingly opens the opportunity for improved diversification to a huge population of serial savers -- not just rich folks.
Unfortunately, because limited partnerships are deemed to be securities, these programs fall under the jurisdiction of the SEC, and the SEC tightly controls communication from CPOs. For instance, broad-based advertising and promotion of commodity pools is prohibited; and pool operators can only post information about their pools on password-restricted Web sites. Prospective investors can reach out to CPOs if the managers are known to them, but CPOs are constrained in the way they can approach new prospects.
This informational blackout is clearly intended as a consumer protection, but the cost has been considerable. The lack of readily available information about CTAs and CPOs has certainly contributed to their limited use by all but a select stratum of sophisticated investors. But why should the less-well heeled be denied the opportunity to do something smart? Small improvements in investment returns translate to large dollar amounts over an extended investment horizon; and that's precisely what managed accounts or commodity pools are expected to deliver. Denying these benefits to smaller investors clearly puts them at a disadvantage.
Choosing A Manager
So how should a prospective investor proceed? Most likely, you'll want to rely on the recommendations of friends or financial professionals to help select a prospective CTA or CPO. Making it hard, however, is that many perfectly competent financial professionals in their own realm are totally ignorant about the world of CTAs and CPOs. In all likelihood the credential that most likely reflects some degree of competency in this realm would be registration with the National Futures Association (NFA). In any case, one way or other, you have to identify and make contact with prospective managers and request their disclosure documents. Answers to the key questions that you should be asking can be found in these offerings.
The dirty little secret is that it's virtually impossible to distinguish skill from luck in this area. Even access to large databases of CTAs or CPOs and a capacity to run a seemingly sophisticated analysis of past returns and volatility may not be sufficient to guaranty a successful choice. Historical data will have little or no value if trading styles are adapted to changing market conditions over time; and, let's face it, that's what happens. Moreover, many if not most programs have limited histories; and as a consequence, the validity of statistical results relating to expected returns, volatilities and correlations should be viewed skeptically.
The starting point should be conceptual: What's the underlying approach described in the disclosure document, does it have intellectual appeal? What markets are covered? Is there appropriate consideration of the tradeoff between risk and reward? Assuming the approach and coverage is compatible with your own interests and sensibilities, it's critical to go beyond the track record. In particular, three key issues that deserve attention:
(1) Who is the manager?
(2) How much has the manager personally invested in the fund?
(3) Are the interests of the manager and the investor appropriately aligned?
Bernie Madoff proved that even seemingly sterling biographies aren't necessarily indicative of honesty or integrity, but relevant experience should count for something. Assuming the biography passes muster, it speaks volumes when a manager's own money is at risk. With that condition satisfied, you should make an effort to assess whether your interests and those of the manager are aligned.
With respect to the alignment of interests, two areas provide useful information. The first deals with the way expenses are treated. You should expect to bear commission charges as part of return calculations, but that's about it. Maybe it's just me, but when someone charges me for an "administration fee," I think it ought to cover such things as overhead, marketing costs, research and data services. In fact, if disclosed, these expenses can legally be shifted to the investors; but that doesn't make it right.