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All you need to know about Commodity Trading Advisors & Commodity Pool Operators
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Questions and Answers
What registrations are necessary to form and operate a CTA?
Are there different types of CTA's?
How long does it take to form a CTA?
What are the approximate costs to form a CTA?
A Commodity Trading Advisor (CTA) is an asset manager that uses a systematic investment strategy when trading in a liquid futures market (a market where an investor can enter or exit a trade almost immediately). Some of the major liquid future markets that a CTA trades in include the S&P 500, Treasury Bonds, and the Euro dollar, and the major liquid commodities markets include crude oil, gold, and corn. There are two major types of CTA's, one is a technical trader and the other is a fundamental trader. A technical trader uses computer procedures, algorithms, and quantatative analysis to determine pricing trends and shifts in the market (this style eliminates any of the trader's personal bias's or emotions), while a fundamental trader analyzes supply and demand data to forecast prices. Registration for CTA's is done through the National Futures Association, a self-regulated organization responsible for reviewing and accepting registrations. There are approximately 800 registered CTA's with the National Futures Association. Most CTA funds require a large minimum investment, sometimes in excess of one million dollars (Quantative Investment MGT LLC requires a minimum investment of 20,000,000 dollars). These funds are attractive to elite investors despite the risk because they can provide returns on their investment of 30%+.
As a result of the world's growing demand for commodities, the popularity of these CTA managed futures grew substantially between 2001 and 2008, with roughly 41 billion under management in 2001 to over 200 billion being managed in 2008. When choosing a CTA, an investor must be cautious to not be distracted by merely a funds return, which can often be misleading, but to look more meaningful statistics like the Sharpe ratio or the Margin to Equity ratio (MTE). The Sharpe Ratio compares the return to the underlying volatility of the investment, i.e. did they get lucky on a risky investment or did they profit from making safe decisions. Some believe that the Sharpe Ratio is flawed because it makes no attempt to predict future volatility, and a better ratio to use would be the Margin to Equity Ratio. The Margin to Equity Ratio (MTE) represents the amount of the Commodity Trading Advisors trading capital that is being held as margin at any particular time, so if a manager has invested $100,000 and $10,000 of that has been borrowed, then their MTE ratio would be 10%. Generally, a conservative CTA manager might hold a margin to equity ratio of 15%, while a more aggressive trader might hold a ratio of 40%. We must warn that past performance is not an indication of future performance and that no ratio will give an investor a guarantee against risk or losses, but they can at least provide data that can help the investor create an educated and strategic decision.
What registrations are necessary to form and operate a CTA?
There are approximately 800 registered CTA's with the National Futures Association. Most CTA funds require a large minimum investment, sometimes in excess of one million dollars (Quantative Investment MGT LLC requires a minimum investment of 20,000,000 dollars). These funds are attractive to elite investors despite the risk because they can provide returns on their investment of 30%+. By obtaining the CTA designation, an AP has to register with both the CFTC and the NFA. A CTA has the ability to register with the CFTC and not the NFA, but not the other way around. If an AP registers as a CTA only with the CFTC they are allowed to give general trading advice, put out newsletters and make recommendations, but they cannot handle clients' money. This is known in the business as a being an "educational" CTA. If you wish to handle client funds then you must register with NFA as a CTA, pay additional fees and adhere to a strict set of rules and regulations.
The NFA requires that CTAs who handle clients' funds must let potential clients know how successful they are in managing money. Both the successful accounts and the unsuccessful accounts must be transparently represented in order to give new clients the best representation of how the manager operates. Another strict rule is that CTAs must maintain segregated accounts for each client that they manage money for. This requires that each account has orders independently executed and trades must be properly allocated to each client's account in order to properly attribute gains and losses. In this way, the CTA is much like the commodities equivalent of a registered investment advisor for an individual's stock and bond portfolio.
In exchange for all of this extra work, CTAs are able to collect a management fee and a performance fee. The management fee is typically 2% of all of the assets under management and the performance fee can range from 20% to upwards of all of the new money raised. As CTAs build their business there is no limit to the amount of capital that they can have under management - if they are good managers.
Are there different types of CTA's?
There are two major types of CTA's, one is a technical trader and the other is a fundamental trader. A technical trader uses computer procedures, algorithms, and quantatative analysis to determine pricing trends and shifts in the market (this style eliminates any of the trader's personal bias's or emotions), while a fundamental trader analyzes supply and demand data to forecast prices.
How long does it take to form a CTA?
There are two career paths that one can take when deciding to become an investment professional. The traditional path of trading or selling securities (like stocks and bonds) can be pursued by taking a test known as the Series 7. This test is administered by the Financial Industry Regulotory Authority (FINRA) and is considered one of the most difficult tests you can take to obtain a professional license. While the Series 7 is important, it does limit professionals to offering only a narrow sector of investments to their clients. The second, lesser-known career path involves taking the National Commodity Futures Examination, otherwise known as the Series 3 test. This test allows anyone in the U.S. the ability to offer alternative investments in commodities and futures securities.
What are the approximate costs to form a CTA?
A futures fund is set up similar to how a hedge fund would be set up. Managers typically set up limited partnerships and pool funds from accredited investors, charging management and incentive fees in addition to the commission earned on returns. Managers usually have at least their series 3 license, Charter Financial Analyst (CFA) designation, and a qualified broker. They do not have to register as an investment company, but a private placement memorandum (PPM) should be created, as well as other documents such as subscription and operating agreements. A PPM is generally an overview of the fund that includes information on the fund's management and general strategies to give investors information about the fund.
Registration requirements vary from state to state, but generally managers must file with their state or SEC if between $25 million and $30 million is being managed. If more than $30 million is being managed the manager must register with the SEC as an investment adviser. The funds may also be regulated by the Commodity Futures Trading commission (CFTC) and the selfregulatory National Futures Association (NFA).
Start-up capital is also crucial for futures funds. Besides registration fees and administrative and legal cost, futures funds must also attract a significant amount of capital from investors. Managers generally invest a significant of their own money in to the fund, which aligns their interest with the investors.
If I manage a futures fund or a commodity pool do I need a CTA?
How does the HedgeCo Legal and Compliance team help me in forming my CTA?
