It’s no secret every industry has a set of terms or words that are only familiar to people within that specific industry. Managed futures might be more complex than most industries. The purpose of this piece is to help investors or new members to the industry understand just exactly what some of those industry related terms mean. It’s hard enough choosing the right CTA to invest with, but if you don’t understand a lot of the terminology, it becomes nearly impossible to be successful. The team at aiSource has complied the following list to help your education process.
Nominal versus Notional versus Cash investment; they all may sound about the same but have very distinct and different meanings within managed futures. The nominal investment amount is usually the minimum investment amount listed on all tear sheets for Commodity Trading Advisors (CTAs), however given that many CTAs only utilize a portion of the Nominal investment amount to conduct investment activity, the entire Nominal amount is not needed to invest with that specific manager or CTA. Instead of the investor putting up the full nominal amount to invest, they can use what’s called notional funds as a tool for investment. It’s important to understand that the following statement is true:
Nominal Investment = Notional Funds + Cash Investment
Margin To Equity
In order to understand what margin to equity means, it’s important to understand the meaning of the word margin first. Margin is the minimum amount of capital needed to hold/own a contract in the futures or options market. For example, if you want to buy and hold 1 mini S&P contract the margin or required capital to hold this position is $4,500 (even though the full contract value is $108,000). You can think of margin as a down payment to hold positions and once you get out of the position the down payment is given back to you (plus/mins profits and losses). Now, moving onto margin to equity. Margin to equity represents the average margin usage of a CTA based on its nominal minimum investment. So, let’s say CTA Y has a nominal investment of $100,000 and on average they use $15,000 in margin, their margin to equity ratio would be 15% (15,000 / 100,000).
A management fee is a fixed fee charged by the CTA in order to manage your account. The management fee is charged as a percentage based on the nominal investment size. This fee can be charged either, monthly, quarterly, bi-annually, or annually. Typical management fees can range from 0% to upwards of 3% depending on the various CTA managers.
Incentive (Performance) Fee
An incentive fee or performance fee is a fee charged separate from the management fee. Incentive fees are charged on the profits that the CTA makes you. Incentive fees can range from 20% upwards to 35% depending on the various CTA managers. One additional caveat to the incentive fee is high watermark. Usually, CTAs will charge incentive fees only after their high watermark value has been reached. There are some CTAs that do not use high watermark and this is something to be cautious of.
Stands for Futures Commission Merchant. An FCM is an entity which allows investors the ability to open a futures account, hold all investor funds and clear all investor’s trades. Although it’s not exactly the same, FCMs are very similar to a Charles Schwab or TD Ameritrade that you see on the equity side.
Power of attorney or more commonly referred to as POA, is the authority an investor gives to a CTA to buy and sell futures & options contracts on their behalf. Although POA gives CTAs the ability to buy and sell on the investor’s behalf, POA does not allow the CTA direct access to any of the funds held in the account. All funds remain in the clients name. Giving a person or a CTA POA over an account simply means you are giving them the authority to trade on your behalf into your account.
Cross margining is only relevant to managed futures investors that use the SMA structure. Cross margining simply means that you place all your cash into one main master account and open “sub-accounts” for each CTA manager that you investing with. The benefit of setting up a master and sub-account structure allows an investor to “cross margin” their cash account with each of their CTA sub-accounts. Each CTA sub-account is able to “draw” money that it needs in margin to conduct trading on a day to day basis. To learn more about cross margining, please read What is Cross Margining in Managed Futures?
QEP stands for qualified eligible persons (QEPs). It is a term used within the managed futures industry to qualify investors. Based on their registration with the NFA, some CTAs are only allowed to accept QEP investors. To learn if you qualify as a QEP investor, please read one of our past newsletters that discusses this in greater detail, What is a QEP?
A disclosure document or also commonly referred to as a DDoc, is a document that must be presented to an investor prior to making an investment with that specific CTA manager. Disclosure documents outline details such as the background of the principals of the CTA, a discussion of the investment strategy being offered, the management and incentive fees being charged, and also discusses any previous or current strategies that the CTA principals offered to investors. Main questions that an investor has, will be answered in the disclosure document. Most all CTAs will have a disclosure document, however if the CTA only accepts QEPs, then they are not required to have a DDoc.