Managed futures funds offer an alternative to investors seeking to add holdings to their portfolio beyond stocks or traditional mutual funds. Rather than being managed by the fund owner, these funds are managed by commodity trading advisors, who are essentially public money managers required to register with the Commodity Futures Trading Commission.
Futures funds offer investors an opportunity to achieve diversification in their portfolios through investments in foreign currencies, precious metals, grains and interest-rate swaps, as well as bond futures and equities indexes. In short, managed futures funds aren’t your typical mutual fund. If you’re an investor who’s contemplating managed futures, there’s one very important factor to consider first: cost.
Managed Futures Funds: Watch for Hidden Fees
According to BarclayHedge, the managed-futures industry held $342.3 billion in assets under management through the third quarter of 2016. The potential for less risk and higher returns associated with these funds has spurred their popularity. In a December 2016 survey 41% of financial advisors said they planned to increase allocations of managed futures funds in their client accounts in 2017.
While the diversification that managed futures funds offer is appealing, it may come at a high cost. In some instances managed futures funds may not fully disclose all the fees they charge to investors. The result is that investors end up parting with a higher proportion of their returns than they may have anticipated. (For more, see 9 Misconceptions About Managed Futures.)
In January 2016, for example, the U.S. Securities and Exchange Commission determined that Equinox Fund Management LLC overcharged investors and failed to disclose its valuation method for certain holdings in one of its managed futures funds, the Frontier Fund. Equinox agreed to refund $5.4 million to investors in excessive management fees, in addition to paying a $400,000 penalty.
A recent Wall Street Journal report sheds further light on pricing within managed futures funds, citing the Equinox Campbell Strategy Fund as an example. That fund, which had approximately $738 million in assets at the end of December 2016, invests in both futures contracts and total-return swaps. This is a vehicle that allows banks to transfer market and credit risk of an underlying asset to leverage greater returns.
What investors may not realize is that the portfolio manager of a managed futures fund may deduct fees from those total-return swaps. For example, the Equinox Campbell Strategy Fund reportedly paid 0.35% of its assets to cover bank fees for its total-return swaps in 2015. At the same time it paid 1% of total fund assets and 20% of trading profits to Campbell & Co. of Baltimore, the fund’s portfolio manager.
In its December 2016 prospectus the net expense ratio for Class A shares was reported as 1.15%. That doesn’t seem unusually excessive in comparison with other actively managed funds, but the problem is that that figure doesn’t include the additional swap expenses. Those costs are instead subtracted from gross returns. The fund’s prospectus specifies that investors may pay an additional 1.35% in combined management and performance fees, but if you’re not reading the fine print, it may be easy to miss.
While the disclosures that managed futures funds provide are sufficient to be in compliance with SEC regulations, there may be a weak link in the chain if an investor is relying on a financial advisor to help steer investment decisions. That could lead to a nasty surprise if you’re investing in managed futures funds with the expectation of higher returns, only to have your investment performance diminished by fees. (For more, see 8 Investing Fees That You Should Never Pay.)
The Bottom Line
Before buying in to managed futures funds, be sure you have a thorough understanding of what you’re investing in – and what you’re going to pay for that investment. If you’re purchasing managed-futures-funds shares through a brokerage or registered investment advisor, ask for a clear explanation of the fee schedule up front. Specifically, find out whether the fund invests in total-return swaps and, if so, what the associated fees are. The more you know beforehand, the easier it will be to gauge how much of a return you can anticipate on your investment.