For decades, access to managed futures has only been available through limited partnerships. The first generation of managed futures products provided access to a single “commodity trading advisor” (CTA). These exclusive products usually carry high investment minimums, provide little transparency, restrict liquidity, and come with high expenses, including incentive fees paid to managers. While early access to the futures markets was beneficial for investment portfolios, the lack of diversification and liquidity carried additional volatility.
The first evolution of futures brought broader access to CTAs in the form of fund of funds – multiple CTAs in a single limited partnership. Futures exposure in this form is more highly diversified with less volatility, but has liquidity constraints and high fees. General partners provide due diligence and oversight of the CTAs, which continue to improve with advances in technology. However, this additional oversight also carries another layer of fees. The fund of funds offer market returns through traditional trend following, and seek to generate additional value through fundamental discretionary trading.
Most recently, 40 Act mutual funds have dramatically changed the landscape of managed futures. With broad access to managed futures markets, systematic trend following has been commoditized. These mutual funds are well-diversified with broad exposure to liquid futures markets. They provide daily liquidity and much easier administration, i.e. no limited partnership paperwork or K-1s. Stated fees are competitive, though it is important to understand any undisclosed fees when evaluating alternative funds.
Within the mutual fund structure, there are four primary strategies to consider:
1) Index – This passive investment strategy employs rules based systematic trading. It offers transparency and a low cost of investing. Because of regulations in the SEC Act of 1940, physical commodities must be traded offshore. However, other types of futures contracts (interest rates, currencies, and stock indices) are traded onshore, which provides for better investor transparency.
2) Single Manager Onshore – A trend following strategy with some active component which can increase expenses. Physical commodities piece must go offshore and some managers employ volatility targeting as a risk management tool.
3) Single Manager Offshore – These active trend following strategies are traded entirely offshore. There is a lack of transparency regarding offshore fees and some underlying managers charge incentive fees. The fund advisor is onshore, adding another layer of fees. Alpha capture can increase expenses and some managers employ volatility targeting
4) Fund Of Fund – A strategy that provides access to multiple trading advisors with trend-following & other diversified strategies. The underlying managers are offshore and there is a lack of transparency regarding associated fees. In some cases, advisors are required to use a trading platform (with additional expenses) to gain access to underlying managers while providing daily liquidity.
The research efforts of the FJY investment committee have led to us to conclude that limited partnerships and offshore mutual funds may be appropriate in certain circumstances, but only if they are able to provide low cost access to trend following and differentiate themselves by adding manager value through fundamental discretionary trading. We have dedicated time to understand the benefits and challenges of holding managed futures in a mutual fund structure, and concluded that access to the broad futures markets in a low-cost, liquid environment offered by the mutual fund structure provides the diversification and downside protection we seek for our client portfolios. Because of transparency and cost considerations, we will recommend index and single manager onshore strategies to replace our client’s existing limited partnership holdings.