In the investing world it is important to understand the costs associated with your different investments. More often than not, investors seek advice from financial advisors to help select the right investment products. Often, some investors can be confused as to how their financial advisors are compensated. This newsletter will help clarify the fees charged by financial advisors, along with an in depth understanding of how commodity trading advisors, or CTAs, collect fees.
It is important to understand how a professional advisor will be compensated before hiring someone to manage your investments. Below is a list of ways financial advisors are compensated for their efforts:
1.) Fee only – under the fee only structure, advisors receive compensation either at an hourly rate or a fixed amount for a specific project that the advisor is working on for you. Another compensation structure that an advisor may charge is a percentage of dollars managed. For example, if the advisor manages $100,000 of your capital, they may potentially charge a 1/2% or 1% management fee on an annual basis (can also be charged quarterly or semi – annually). This type of fee is collected directly from the client.
2.) Commission Only – under the commission only structure, advisors do not collect any fees directly from their clients. However, they receive commissions from the companies which provide the financial products they provide to you.
3.) Fee based – under the fee based structure, the advisor charges a combination of the compensation methods above. The advisor will charge a small fixed amount to the investor (collected directly from the customer) and will also receive commissions based on the products they recommend.
Each of the above fee structures have their positives and negatives. It is important to completely understand the fee structure that your financial advisor is charging you.
Now that we’ve discussed the different ways that financial advisors earn a living, it’s also important to note how their fees vary within the managed futures space. The biggest difference between the two fees, is that managed futures fees are heavily weighted based on the performance of the investment. Here is a breakdown of fees associated with investing in managed futures/Commodity Trading Advisors:
1.) Management Fees: similar to the “flat-fee” charged by financial advisors (as described above), managed futures generally carry an annual fee of 1% to 2% of the investment amount. This fee is collected directly by the CTA(s) with whom you are investing, and collected monthly or quarterly on a pro-rated basis.
2.) Incentive Fee: this fee is also sometimes referred to as a “performance fee,” and is also charged directly by the CTA(s) that manage your accounts. Incentive fees are taken as a percentage of profit that the CTA earns for the investor – this is limited to only new profits, and is subject to the high water-mark rule. Incentive Fees range from 20% to 30% and are generally collected monthly or quarterly.
All the fees described above are charged by the CTA and may, in certain instances, be shared with firms like aiSource as compensation from introducing clients to the CTA. Another set of small fees to be aware of when investing in managed futures, is the transactional fees charged when a CTA places trades in a client’s account. The transactional fees are charged on a per trade basis and are passed through to the client. It is important to remember that all historical returns reported by a CTA are NET of all fees.
While every investment type carries fees, it is important to be aware of the fees that are charged by each of your investments – whether they are traditional investments offered through financial advisors, or managed futures offered through alternative investment firms like aiSource. After analyzing fees closely, you may realize that certain investments are not worthwhile, or realize that certain investments offer you “more bang for your buck.” Regardless of the fees, it’s important to remember the significance of having a diversified portfolio, and that diversification may outweigh the costs related to investment fees.
-Paul Kokuzian
Sources: http://www.sec.gov/investor/pubs/invadvisers.htm
Disclaimer: Please use the above material strictly for educational purposes. Past performance is not indicative of future results. Futures trading involves substantial risk of loss. By no means is this newsletter offering any investment advice or suggesting to make any trade recommendations. Please consult an aiSource advisor prior to opening any managed futures accounts.