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Managed Futures Mutual Funds – Can’t Beat The Real Thing

The allure of managed futures is obvious. Over the past decade good managers have far outpaced the general stock market, and just as importantly during the worst market years these managers have bucked the overall trend and given investors an excellent source of diversification. With their benefits it's no wonder that managed futures strategies are beginning to make their way into the mutual fund market.

The big question is why did these funds take so long to launch? The answer to this lies in the regulation of managed futures. Typically these strategies are regulated by the Commodity Futures Trading Commission (CFTC) and are only made available to accredited investors who have a net-worth greater than $1million or have made over $200k if single and $300k if married. These hurdles originally made it impossible for the existence of a managed futures mutual fund until 2003 when the CFTC made some significant changes paving the way for Rydex to launch the first managed futures mutual fund in 2007.

These mutual funds continue to gain popularity with a new fund launch every few months. However, upon doing a due diligence on these funds I couldn't help but be underwhelmed again and again. Even though these funds are held out to the investment community as being "Managed Futures" most of them actually had a majority of their portfolio held in cash or short term fixed income. Here is a list of the largest players in the space currently:

Symbol Fund Name Cash & Bond % Fee
RYMTX Guggenheim (Rydex) Managed Futures 92.28% 1.97%
MFTAX Altegris Managed Futures 79.77% 3.86%
AMFAX Natixis ASG Managed Futures 83.18% 1.70%
AQMIX AQR Managed Futures Strategy 84.00% 1.25%
MFBPX Aspen Managed Futures 42.39% 1.80%
GPFAX Grant Park Managed Futures Strategy 75.13% 1.95%
LFMAX LoCorr Managed Futures Strategy 74.53% 2.20%
PFFAX Princeton Futures Strategy Fund 71.12% 2.21%
RTSRX Ramius Trading Strat. Managed Futures 82.41% 4.53%
WDTI WisdomTree Managed Futures 104.56% 0.95%

Data Compiled From Morningstar 2/23/2012

The reason for this low allocation to managed futures in these funds is that under the Investment Company Act of 1940 that governs mutual funds, a fund cannot have more than 25 percent of its holdings in any one security. Currently these funds are primarily investing in managed futures through the creation of offshore subsidiaries based in the Cayman Islands that hold the managed futures for fund owners. So unless these funds are able to harness a huge amount of leverage (which is theoretically possible in futures markets) it seems impossible for them to obtain returns created by the traditional managed futures model where 100% of one's investment goes to work with the fund manager.

Another big headwind for these funds is going to be their large internal expenses. While its not unusual for a traditional managed futures manager to charge 2% plus a 20% incentive fee, these funds are all trying to charge the equivalent fee even though most have 70% or more in cash or short term fixed income that is yielding near 0%. If only 25% of the fund is at work in managed futures this means that the underlying manager needs to make 8% annually just for the fund to get to break even on the 2% total fund expense.

Upon looking at the returns of these instruments over the past few years none of these managers are currently proving that they are capable of creating returns that are sufficient to overcome the internal fees. While the idea of adding managed futures to one's mutual fund portfolio seems good on paper, it would appear the devil is in the details. Until regulations or fees change in regards to these funds it would be wise for investors to avoid managed futures unless they have access to the real thing.

Disclosure: I have no positions in any stocks mentioned, and no plans to initiate any positions within the next 72 hours.