A recent Bloomberg Markets article by David Evans, “Fleeced by Fees,” raises several valid points but leaves critical “misimpressions,” a word the Evans uses to describe how managed futures is misrepresented to investors.
The primary thesis of the article is that managed futures hides and mis-represents fees to investors while enriching fund managers and eating most investor profits in the process.
While many of Evan’s assertions are correct, perhaps the most serious issue is how the article omits key facts.
For instance, the key fact is that the National Futures Association (NFA), the self regulatory body for the managed futures industry similar to FINRA for equity-based financial advisors, requires that Commodity Trading Advisors (CTAs) and Commodity Pool Operators (CPOs) who offer investments to the public report performance net of all fees, as is clearly outlined on page seven of the disclosure document reporting guidelines from the regulator. This document addressing the clarity of CTA investor disclosure clearly states “The disclosure document must include a complete description of each fee the CTA will charge.”
Also omitted from the article was the fact managed futures CTAs and CPOs who offer investments to the public that fall under the NFA regulations are required to report performance net of all fees and commissions – net net. As outlined on page 12 of NFA disclosure requirements to calculate performance the NFA has a simple standard formula of subtracting the month ending asset value of the account (ENAV) from the beginning net asset value (BNAV). All fees, commissions and expenses taken out of the investors account during that period of time are factored into the profit loss reporting.
What is missing from the Bloomberg article is any mention of these disclosure requirements, which, if not followed, could lead to the CTA or CPO being banned from the industry.
For its part, the NFA says this information was provided to the Bloomberg reporter in an interview that occurred with multiple people present as witness but Bloomberg never reported the information.
These material facts omitted from the article stands in sharp contrast to Evan’s primary message that fees are hidden and non-transparent in all of the managed futures industry, which is factually inaccurate. Evan’s fails to make any meaningful distinction between different managed futures account types and varying levels of fees and performance reporting requirements.
While the article is accurate in the assessment that fees in certain investment products offered by Wall Street wirehouses and Broker Dealers are high and gobble up investor profits, this didn’t tell the whole story. Such non-transparent fees are not the case with all managed futures account types and even some certain managed futures mutual fund providers have a strict policy capping all fees and expenses at 2% and some are even transparent regarding how they operate the strategy.
Most important, had the author dug a little deeper or reported all the information he would have realized you could have substituted the words “managed futures” for “mutual fund” and the article would have been equally accurate. The issue is the fund product structure adding layers of fees but taking away transparency from the core, a direct managed futures segregated account structure. While the article paints the entire managed futures as a whole in a negative light, this is not accurate as certain account types not offered by Wall Street wirehouses have very different performance reporting standards than a direct managed futures account, which underlies all the managed futures products.
The Direct Managed Futures Account
In an apparent attempt to paint the managed futures industry with one oblique brush, Evans failed to raise the critical distinction between a direct managed futures account offered by a Futures Commission Merchant (FCM), and the fund structure account types offered by Broker Dealers and wirehouse financial advisors.
What should have been included in the discussion is that all managed futures investments are based on a direct managed futures account held at a FCM that fall under segregated account regulations. This account type is entirely transparent on a daily basis – investors can even peer into the trades and exact positions the CTA has placed, something unheard of in the hedge fund community – and performance is required to be reported net of every fee, commission and expense. It is the ideal account type: generally low friction and complete transparency being regulated by an organization with a reputation as playing hard-nosed with those being regulated. (Some industry executives are on record as calling industry regulators the “Gestapo” and regulators have been accused of being overly aggressive.)
The key point is that once the managed futures account type changes into a fund product, the NFA loses a significant degree of regulatory control over disclosure of fees and performance reporting.
Knowledgeable institutional investors and high net worth individuals typically access managed futures through the direct account or when they access it through a fund product they do so through low fee account structures where all costs are clearly spelled out up front. The article actually gives an example of this when referring to investors in Winton Capital, but strangely fails to mention the critical difference between a direct managed futures account and the non-transparent fund account with different performance reporting standards.
The Foundation of All Managed Futures Products: The “Direct Account” Structure
In order to distribute managed futures to retail investors, some – but not all – fund products take the transparent managed futures direct account, wrap it in a fund product for distribution to retail investors while adding hidden fees and expenses and eliminating transparency. At the core of all managed futures products is the gem of the direct account structure.
The article touches on this very issue by mentioning that pension funds and other institutional investors typically reap the rewards of managed futures, retail investors bear the brunt of fees. Citing a $1 million investment in Winton Capital, which returned 11.9% during the generally rough 2009-2012 period of time, the article went on to accurately note that a retail investor who invested in a Winton-based fund product from as separate third party product marketer, Altegris, was fee heavy experienced a 10% loss over the same period of time. The article failed to mention the distinction between an NFA regulated direct managed futures account and a fund product, not regulated by the NFA.
To knowledgeable professional investors and those on the inside of the managed futures industry, this didn’t come as a surprise. Over the past several years there was a fight between the SEC and the CFTC over disclosure of fees for managed futures mutual funds, with a battle over performance tables inclusive of all fees and expenses vs traditional oblique mutual fund reporting being a key component of the fight. Again, this battle strangely didn’t make it into the Bloomberg article that was supposedly researched over the course of several months.
BarclayHedge CTA Database: Other Facts Omitted
The article takes on the BarclayHedge CTA Index, accurately noting that CTAs can stop reporting to the index but failing to mention this hedge fund reporting methodology is similar to other hedge fund indexes and reporting services. The article also fails to mention that once a CTA stops reporting strict rules prevent it from simply starting to report again and other methods are in place to present inaccurate performance reporting. Failure of a CTA to report to such database reporting services could raise significant questions among professional asset allocators and damage the CTA’s business. The issue of CTAs stopping reporting is known as “survivorship bias,” yet the Evans fails to address academic study in any meaningful way. For instance, the survivorship bias rate of the BarclayHedge CTA index is just slightly higher than that of the S&P 500, according to BarclayHedge and confirmed by my 6 year study of the Barclay CTA Graveyard database.
The Bloomberg article also fails to mention that each CTA regulated by the NFA offering investments to the public undergoes an extensive audit. This includes review of each and every account and confirmation of the publicly reported performance – including checking of how CTA performance is reported to major CTA databases such as the BarclayHedge CTA reporting service.
The article charges that the CMEGroup omits key facts to investors by utilizing BarclayHedge data in its reporting of performance. Specifically the article says the BarclayHedge database fails to account for fees, but this is inaccurate to a significant degree. The BarclayHedge CTA Index – and more specifically the Barclay BTop 50 Index – are significantly represented by managed futures direct accounts – well over 60%, according to recent study. Anytime a direct managed futures segregated account reports performance, this performance is reported net of fees, a critical fact the article failed to mention. In regards to managed futures study, the BarclayHedge BTop 50 has a much lower survivorship bias rate than does the more general BarclayHedge CTA index, but this was not mentioned.
The article ends by quoting an NFA representative Mary McHenry as saying the regulator doesn’t have a requirement to clearly present how fees have consumed returns over time. “We don’t have a requirement where they have to present that information. That would be valuable,” she was quoted as saying.
For its part, the NFA said that the fee performance reporting guidelines were clearly outlined in the interview but these facts were omitted from the article.