Taking the Mystery Out of Managed Futures for Your Clients

Managed futures are increasingly used in creating diversification and asset allocation strategies aimed at advancing the clients’ portfolio values and a firm’s business. Removing the mystery for clients is key.

If your clients have been asking for more investment options, added diversification and recommendations on tax-advantaged opportunities for their portfolios, a discussion about managed futures be the answer. Helping them understand exactly what managed futures are, why they may be a viable investment option, and what the advantages and disadvantages are, can remove the mystery and gauge interest in this alternative investment.

Why Managed Futures?
Put simply, managed futures create a diversification and asset allocation strategy to help advance the value your clients’ portfolios. Additionally, there are potential tax advantages.

“Managed futures have historically displayed a strong non-correlation to equity markets and can provide good returns when the market has gone down,” says Paul Rieger, Commodity Broker – Managed Futures Specialist with MF Global (a leading cash and derivatives broker-dealer). “This lack of correlation potentially helps reduce portfolio risk and smooth out returns, potentially covering larger draw downs.”

Rieger also notes that managed futures provide exceptional access to the typically thought of commodities like meats and grains as well as those not immediately thought of, like financials, currencies and fixed income. Rounding out the reasons why, he cites the fact that managed futures implement “absolute return/alpha generations,” as returns generated can be independent of financial markets. Managed futures also have increased transparency and liquidity compared to hedge funds.

According to the CASAM CISDM CTA Equal Weighted Index, for the years 1980 to 2010, managed futures had a compound average annual return of 14.52%, while U.S. stocks (based on the S&P 500 total return index) returned 7.04%.

Now consider some tax advantages. According to the Tax Act of 1981, short-term profits (held for less than 12 months) in commodities are treated as 60% long term and 40% short term. Conversely, short–term trading profits in stocks are treated as 100% short term. For investors in higher tax brackets, this tax treatment can mean better tax savings on short–term gains with commodities versus stocks.

But why stop there? Contemplate for a moment the income growth and tax savings your clients could realize if they invest in managed futures with a self-directed IRA or retirement plan. They gain the true power of compounding interest since the investment is made in a tax-sheltered environment as their earnings grow tax free.

“Many customers invest through retirement accounts to give them representation in a broad array of markets,” states Shira Pacult, Director of Managed Futures with Futures Investment Company. “As well as providing diversification, we can participate in rising, falling, and trendless markets. Since customers may have access to funds in IRAs, they may be able to invest as long as it’s appropriate relative to their entire portfolio size.”

Pacult, who’s specialized in managed futures for 30 years, also notes that an investment in futures involves substantial risk and is not suitable for all investors. Her firm and its affiliates are registered as a commodity pool operator, a commodity trading advisor, an introducing broker, and a broker-dealer offering managed accounts as well as managed futures funds.

Explaining Managed Futures to Your Clients
A good place to start with clients is to explain what “futures” are. Here’s a quick explanation: A future is often a commodity. A commodity is a crop or metal that is a tangible object like corn, wheat, coffee, sugar, silver, gold and heating oil.

Next, try a simple explanation of a futures contract: A futures contract is an agreement to buy or sell goods (commodities), currency or securities on an agreed future date and for a price fixed in advance. Futures contracts detail the quality and quantity of the asset and are standardized to facilitate trading on a futures exchange.

To help clarify, mention to your client that he or she may have already entered into a futures-like contract. Try something like this: You’re familiar with cable TV, right? As a subscriber or buyer, you sign a contract with a cable company to receive a specific number of channels at a certain price for the next two years. This is very similar to a futures contract. You agreed to receive a product at a future date with price and terms for delivery already set; you secure your price for the next 24 months (even if the price of the service rises during that time); and because of the contract, you’ve reduced your risk of higher prices.

Now for a simple explanation of managed futures. Maybe something like: “Managed” futures are the trading of futures contracts by professional Commodity Trading Advisors (CTAs) in global futures and options markets (as either buyers or sellers of contracts). These contracts represent the previously mentioned commodities like silver, gold, corn, wheat, coffee, sugar and heating oil, plus financial assets like government bonds, equity market indices and currencies. The CTA makes all trading decisions on your behalf through a revocable power of attorney.

Here’s a timely example of how managed futures work that you can mention to clients: A few years ago, gold prices were at a record-breaking low. Recently, gold prices rose to an all-time high. Those CTAs who successfully projected the future and purchased gold at a low price waited to sell the managed future contract when the price was at an all-time high to make the best profit.

But putting all of your managed future eggs in one basket (like gold) may not be a wise move.

“It’s important to have diversification even within managed futures investments,” advises Rieger. “The potential benefits are reduced volatility, enhanced returns and protection from extreme down moves in the markets.”

Rieger suggests conversations with people who have experience working with managed futures. He also notes the ability to work with pools or funds of CTAs who provide investor access to a variety of managed futures.

Pros and Cons of Managed Futures
Of course, managed futures aren’t for every client. But those who have more than a passing interest should be provided with factual information to ensure understanding of the both the possible advantages and disadvantages involved. Additionally, coach your clients on having realistic expectations about the return on investment of managed futures.

The potential benefits of managed futures include the opportunity for:

• More investment options
• Enhanced portfolio diversity
• High returns
• Reduced portfolio volatility risk
• Profit in any economic environment
• Participation in global markets

The disadvantages of managed futures include:

• Minimum net worth and/or income requirements for clients
• No participation in trading decisions
• High risk and potential trading losses
• Substantial management fees, administrative costs and incentive fees
• No guarantees and volatility
• The possibility of human error because a manager is involved

Helping your clients understand alternative investment avenues like managed futures as well as optional ways to invest through a self-directed IRA can benefit your business and keep you in good standing with current clients. You may also earn their referrals. And that takes some of the mystery out of how you’ll continue to grow your business.

Want to learn more? Join our Special Webinar Series "Move the Dial with Managed Futures"

The first in an upcoming series of webinars "A Case for Managed Futures: How to Increase Business During Up and Down Markets” happens December 8, 2010 at 2 p.m. ET. This webinar series is presented by Sterling Trust, a division of Equity Trust Company, and MF Global, a leading cash and derivatives broker-dealer.

This educational and enriching webinar covers these topics and more:

• Understanding managed futures
• The key benefits of low-correlated assets in the allocation mix
• How managed futures offer easy access to a broad spectrum of asset classes and markets
• Managed Futures are not just about commodities – discover the many assets used for managed futures
• Why managed futures have increased transparency and liquidity compared to hedge funds
• Diversifying retirement accounts in managed futures (presented by Sterling Trust)

Future webinars in the series will address that managed futures are more than just commodities, they can include currencies, equity indices, fixed income futures and much more.

Disclaimer: Futures trading involves risk of loss and is not suitable for everyone.

Access the Network Now to Register!

Join the Equity Trust Financial Network for CPAs, attorneys and financial professionals to get more details and sign-up for this exclusive webinar.

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Disclaimer: Equity Trust is a passive custodian and does not provide tax, legal, or investment advice. It does not endorse or recommend any contributor, company, or specific investments. Any information communicated by Equity Trust Company is for educational purposes only and should not be construed as tax, legal, or investment advice. Whenever making an investment decision, please consult with your legal, tax, and accounting professionals.