THE BLOG
06/25/2009 05:12 am ET | Updated May 25, 2011

Bandaged Futures?

After 2008 -- the year Hurricane Excess pummeled the markets -- we're all struggling with our investments. Is anything safe? What can we trust? Who can we trust?

Today, The New York Times described the search for answers in "Time for a New Strategy". I keep hearing two words: managed futures. Supposedly, they herald the dawn of an enlightened age for investments.

Sounds interesting. I want to manage my future.

The Wall Street Journal reviewed this asset class last Saturday: "Should Managed Futures Be in the Cards for You?" Many advisers are extolling the virtues of these investments.

What the heck are they?

Jason Zweig of The Wall Street Journal offered a fair and balanced review. Let's break down his article and figure out why I've labeled them "bandaged futures."

WSJ: "The returns on this commodity-trading strategy don't look good -- they look spectacular. The average managed-futures program, as measured by the Barclay CTA Index, was up 14% last year -- beating the stock market by a staggering 51 percentage points. Run by commodity-trading advisers, or CTAs, these funds manage an estimated $199 billion and may traffic in anything from corn, cotton and crude oil to interest rates, currencies and stock indexes. They often use technical analysis and mathematical formulas to trade on price patterns."

Norb: Good overview of the asset class. I find it odd that corn and interest-rate futures sit in the same bucket. I understand the reason. Algorithms and charts drive trading decisions -- not the underlying entities. Futures and commodities are separate securities just as real estate and mortgages are two distinct investments.

But still, corn and interest rates in the same breath?

We use manure to grow corn. Interest rates are more a function of fiscal policy, money supply, and political jawboning.

On second thought, maybe the two do share something in common.

WSJ: "The Barclay CTA Index has gained an annual average of 12.2% since 1980 and lost money in only three of those calendar years. Academic research shows that commodity futures have kept pace with inflation and rivaled the returns on stocks, with the extra virtue of tending to go up whenever stocks or bonds go down."

Norb: Several years ago, we were all reading about a commodity super-cycle. The BRICs (Brazil, Russia, India, and China) -- China in particular -- were consuming more and more of the world's natural resources. We watched prices spike with incremental demand. Intuitively, it seems there is a link between the performances of managed futures and underlying commodities.

But what happens if commodity prices flat-line or drift lower? How will global recession affect managed-future returns?

Attached is a must-see documentary. The film explains the correlation. It offers enduring images from mavens who made their mark in the brass-knuckled world of commodities and derivative instruments. All it takes is 7.12 minutes of your time.

Can you afford not to watch?

WSJ: "Still, flameouts are common. A 1997 study found 20% of managed-futures programs disappear each year. Sol Waksman, president of BarclayHedge in Fairfield, Iowa, estimates his firm's Barclay CTA Index replaces roughly 15% of its constituents annually."

Norb: Uh-oh.

The returns suggest survivor's bias. The asset class sounds great. Unless we back the wrong horse and fall into that 15 percent category.

WSJ: "Most futures traders put up 15% or less of the purchase price of the contract as "margin" or cash collateral."

Norb: In other words, the traders borrow 85 percent or 5.7 times their equity stake.

Isn't that how we got into this mess?

WSJ: "Fees on managed-futures funds make mutual funds seem cheap. Many CTAs charge a 2% management fee, plus 20% of any "net new profits." The fund can incur high trading costs. You may have to pay an "introducing broker" as much as 6% to get into the fund. All told, the costs can hit 6% to 8% annually, says Ruvane's Mr. Lerner. Of course, returns are reported after all fees (except sales charges) are deducted."

Norb: Excuse me? You're kidding, right?

I'm skeptical about the long-term viability of any investment with fees of 6 percent to 8 percent annually. A six percent front-end fee is a non-starter for me. It reminds me of that card in Monopoly: "Do not pass go. Do not collect $200."

I know some readers will disagree. Let me hear from you.

www.acrimoney.com