FAQ Contents

1. What are managed futures?
   
   Managed futures are the systematic or discretionary trading of futures contracts by professional Commodity Trading Advisors (CTAs) who trade in global futures and options markets, as either buyers or sellers of contracts representing real assets such as gold, silver, wheat, corn, coffee, sugar and heating oil, as well as financial assets such as government bonds, equity market indices and currencies. The CTA makes all trading decisions on behalf of the client through a revocable power of attorney.
2. What´s a CTA?
   
   A CTA is a Commodity Trading Advisor. A CTA is an individual or organization which, for compensation or profit, advises others as to the value of or the advisability of buying or selling futures contracts or commodity options. Providing advice indirectly includes exercising trading authority over a customer´s account as well as giving advice through written publications or other media. Membership with the National Futures Association (NFA) is required unless:

   1. You have provided advice to 15 or fewer persons during the past 12 months and do not generally hold yourself out to the public as a CTA or
   2. You are in one of a number of businesses or professions listed in the Commodity Exchange Act or are registered in another capacity and your advice is solely incidental to your principal business or profession.
3. How do managed futures compare to stocks and bonds?
   
   Generally speaking, because managed futures have little correlation to stock and bond markets, it is quite difficult to make a comparison. It may be common practice for investors to dissect the individual elements of their portfolio and expect them to compete with one another over every time period. However, effective and prudent asset allocation would suggest that:

   • Managed futures cannot be looked at in isolation from the rest of the portfolio, nor should they be examined in relation to the stock market.
   • It is very important to ensure investors have a balanced approach to investing, to understand the rationale behind allocating portions of assets to different investment classes, styles or instruments, and that they always keep their long–term goals in mind.
   • Different instruments within their portfolio should complement each other, not compete with each other. It is important to remember that different investments derive profitability from a variety of economic and market scenarios, and that investments will not all perform at the same time. Otherwise, all investments would make money together and all would lose money together.
4. How are managed futures used in an investment portfolio?
   
   With prudent allocation, managed futures may help reduce the overall risk of a portfolio. A prudent investor should ensure that at least a portion of their portfolio is allocated to an alternative asset class that has the potential to perform well when other portions of the portfolio may be underperforming.

   Other potential benefits of managed futures may include:

   • Historically competitive returns over the longer term.
   • Returns independent of traditional stock and bond markets.
   • Access to global markets.
   • The unique implementation of traditional and non–traditional trading styles.
   • Potential exposure to as many as one hundred and fifty markets globally.
   • Liquidity and no lock–ups. The contracts in which the CTAs trade typically have a high degree of liquidity. If suitable to a client´s objectives, devoting five to fifteen percent of a typical portfolio to alternative investments has been shown to increase returns and lower volatility. Because alternative investments may not react in the same way as stocks and bonds to market conditions, they may be used to diversify investments over different asset classes, resulting in less volatility and less risk. The other attractive feature of the PFGBEST Managed Futures product is that there are no lock–up of funds or penalties for early withdrawals.
5. How can diversification through using managed futures help reduce risk?

   During times of market volatility or declining stock and bond markets, managed futures may be an important part of your portfolio. The PFGBEST blended portfolios are customized structured products, which over time are designed to provide investors with exposure to a set of strategies with little correlation to the stock and bond markets. In the event of a major, sustained downturn of the equity or fixed income markets, managed futures may potentially provide some protection for a client´s overall portfolio. Increasingly sophisticated institutional investors such as pension funds, endowments, foundations and family offices are allocating larger portions of their portfolios away from equity and fixed income into alternative investments. Managed futures are a sub–class of alternative investments.

6. Who regulates Commodity Trading Advisors?

   Commodity Trading Advisors are regulated by the Commodity Futures Trading Commission (CFTC) and by the National Futures Association (NFA), the congressionally authorized self–regulatory organization of the futures industry. All trading advisors must be registered with the CFTC and those who manage customer accounts must be members of the NFA. Advisors´ Disclosure Documents are required to be submitted to the NFA for review in advance of distribution to prospective investors. On an ongoing basis, the NFA audits Disclosure Documents (particularly performance information), promotional materials, and trading activities. Many CTAs update their performance data on a monthly basis. Violations of CFTC or NFA rules can result in financial penalties, suspension or complete cessation of trading privileges and other penalties.

7. What are the costs, and how do CTAs get paid?

   There are basically three types of charges involved when a managed account is handled by a CTA. An annual management fee usually between 1–2 % of the value of your account is charged for the overseeing of the trading in your account. Normally this fee is charged in monthly, for example a 2% annual fee would result in a 0.1667% monthly charge being applied to the account. Most CTAs also charge a performance incentive fee which typically runs from 15% – 25% of the cumulative net trading profits calculated at the end of each quarter. The net trading profits are the combined total of profits and losses from trading. Other costs associated with a managed futures account include FCM brokerage costs, exchange and regulatory association fees.

8. How much money should I invest in managed futures and how do I open an account?
   
   We recommend that the amount of money you invest be based on your own financial goals and risk tolerance. This should usually be approximately 5%-20% of your overall portfolio. Only risk capital should be used in managed futures or any speculative investment. Before opening an account, you must be supplied with a copy of the CTA´s Disclosure Document. Read it carefully and go over any questions you have with your broker before you invest. After your questions have been answered and you feel this type of investment is appropriate for you, we will assist you in completing the CTA Management Agreement and PFGBEST Customer Agreements and account opening forms.
9. Are there any tax benefits to investing in managed futures?
   
   According to the Tax Act of 1981, short–term profits (held for less than one year) in commodities are treated as 60% long term and 40% short term. On the other hand, short–term trading profits in stocks are treated as 100% short term. For individual investors in higher tax brackets, this tax treatment can mean saving as much as 30% on taxes on short–term gains on commodities versus stocks. PFGBEST strongly recommends that you should discuss the taxation elements relating to your investment with an independent qualified tax advisor.
10. Are managed futures suitable for all investors?
    
    Managed futures are not appropriate for everyone. A determination must be made as to a particular investor´s suitability, the investor should be provided with all of the necessary information to make sure he or she understands both the risks and possible rewards of this type of investment. In addition to having the required risk capital, an investor needs to have realistic expectations about returns on investment and tolerance to drawdowns that may occur with managed futures products. The risk of loss always exists in futures trading no matter how skilled a trader an individual CTA may be.
11. Why is the CTA’s Disclosure Document so important?

    CTAs and CPOs (Commodity Pool operators) are required to file Disclosure Documents with the NFA. The basic disclosure requirements are intended to ensure that potential investors will be apprised of material facts regarding managed investments and advisors so that they can make an informed decision about a particular investment or advisory service before committing their funds. The CFTC, in November 1997, delegated to the NFA the authority and responsibility to conduct the reviews of Disclosure Documents of both CTAs and CPOs required to be filed with the commission.

    Only upon satisfactory review of the Disclosure Documents and subsequent approval by the NFA, can a CTA or CPO offer his Disclosure Document to the public for consideration. Disclosure Documents provide biographical information on the CTA and generally reviews the trading style and account management philosophy of the CTA, as it applies to that particular program. The Document will also contain a review of the trading program along with a list of all fees, potential conflict of interest issues, and a description of the CTA´s risk management methodology.

    Performance records are also reviewed showing the net trading results after costs have been deducted.

12. What is the minimum investment needed to establish an account?
    
    Each CTA has their own minimum account size and that can vary from as low as $25,000 to multiple millions. Generally speaking the newer CTAs have lower minimum entry requirements as they are still in asset building stage whereas older, more established CTAs tend to have higher minimum account requirements.
13. Have there been any performance comparison studies between self-directed traders and CTAs?
    
    There are some individual investors who are highly successful in directing their own futures trading if they have the knowledge, experience and resources to do so. However the vast majority of self-directed investors have struggled in their efforts to become successful in futures trading. Studies indicate that as many as nine out of ten self-directed traders lose money. When it comes to managed futures, of the 119 funds and pools in the Managed Account Reports Fund/Pool Qualified Universe Index that traded from January 1990 through October 1996, 81% were profitable over the full time period.(Source —MAR)
14. How does an investor interpret a track record in judging the performance of a CTA?

    Investors should take particular note of the Trading Advisors Performance Record. However, this in itself should not be the sole reason for choosing a specific CTA. As mentioned above, the Disclosure Document spells out an advisors philosophy and trading style. This should be reviewed along with the track record in making your decision. Track records are important and should show performance tables, spanning several years or more. A strong performance over a short period of time may be nothing more than good fortune. However, positive performance over a long period of time, especially in markets that have experienced bull bear and flat trading ranges, speaks volumes about a CTA´s trading abilities.

    Track Record Components to take careful note of:

    Length of the trading program……………Good fortune or sustainable investing?

    Worst peak to valley drawdown…………Could your account be profitable assuming worst entry?

    Assets under management ………………Has the manager significant assets under management?

15. What is correlation?
    
    The correlation of a trading program to other investments is an integral part of building a successful investment portfolio. Not only is it important to not be correlated to other CTAs in the portfolio, it also very important that the CTA you are considering fits in your traditional stock and bond portfolio. The goal of a well–balanced investment portfolio is that when some assets are losing value, the other assets are gaining value.
16. What is a front end load fee?

    A commission or sales fee charged by the broker at the time of the initial purchase for an investment. The broker who charges front end load fees must get the investor to read and sign a break even analysis

17. What is a break-even analysis?
    
    A break-even analysis shows the fees and expenses investors can incur on an initial investment in a pool or program, and the dollar amount that the pool or program must earn for the investor to break even after one year. A break-even analysis must be given to investors when a front load fee is being charged.
18. What is notional funding?
    
    Notional funding is the term used for funding an account below its nominal, or face value. Anyone who has been involved in futures, options or forex knows that an account with a nominal value of $1,000,000 does not necessarily mean that there is $1,000,000 cash in the account. Accounts may be funded for less than the $1,000,000 as long as the cash deposited meets the margin requirements set by the exchange or the futures commission merchant (FCM). The difference between the nominal value and the cash actually deposited is called notional funding.

    To illustrate, assume a CTA has a minimum nominal amount of $1,000,000, and the margin requirement is $50,000. The investor can either deposit $1,000,000 to fully fund that minimum investment requirement or, alternatively, can invest only a portion of the $1,000,000, as long as that meets the $50,000 margin requirement. Assume that the investor decides to fund the $1,000,000 account with $100,000. This means that the investor is using leverage of 10X — 10 x $100,000 = $1,000,000, the minimum investment. The difference between the nominal value ($1,000,000) and the cash deposited ($100,000) is $900,000. The $900,000 is referred to as notional funding.

    Investors are interested in using notional funding because the notionally funded amount (in this case, the $900,000) is not borrowed or deposited—the cash ($100,000) is a good faith deposit for the full value of the account. In other words, the $100,000 trades as if it were $1,000,000, even though the investor only deposited $100,000 and is not paying interest or has not otherwise borrowed the remaining $900,000. If the account is doing well, the investor earns money on the full $1,000,000 — even though he only funded the account with $100,000. If the account is not doing well, however, the investor is responsible for the amount lost, regardless of the cash the investor originally deposited.

    For example, assume that the account has a profitable year, and the CTA reports profits of 20% ($1,000,000 x 0.20 = $200,000) for the fully funded account. The account that was only funded with $100,000 also had $200,000 in gains — but the investor´s profit percentage was 200%, because the investor earned $200,000 on a $100,000 investment.

    Investors must be aware, however, that this is a double–edged sword. If the account has a drawdown, the investor will suffer a significantly larger percentage decline than the fully funded account. If the example above suffered a 20% drawdown for the fully funded account, the notionally funded account would have a 200% drawdown. In such a situation, the investor would not only have lost his initial $100,000 investment, but an additional $100,000 on top of it. Furthermore, to keep the account open, the investor would have to deposit at least enough cash to cover the margin requirement. In this regard, notional funding significantly increases the volatility of an account. Investors must ensure that they understand how much leverage the CTA is using — and the consequences such leverage might entail.

19. What is total return?

    The total percentage return of an investment over a specified period, calculated by expressing the difference between the investment´s initial price and final price as a percentage of the initial price.

20. What is compound annual return?

    This is the rate of return which, if compounded over the years covered by the performance history, would yield the cumulative gain or loss actually achieved by the trading program during that period.

21. What is average annual return?

    A percentage figure used when reporting the historical return such as a three, five or ten year average returns for a CTA program.

22. What is monthly standard deviation?

    Each monthly rate of return = ((VAMI at end of month / VAMI at beginning of month) – 1)

    Standard deviation = SQRT ((Sum(monthly ROR – average monthly ROR) ^ 2)) / # of months)

23. What is the Sharpe Ratio?

    The Sharpe ratio is a measure of risk–adjusted performance that indicates the level of excess return per unit of risk. In the calculation of Sharpe ratio, excess return is the return over and above the short–term risk free rate of return and this figure is divided by the risk, which is represented by the annualized volatility or standard deviation.

    In summary, the Sharpe ratio is equal to compound annual rate of return minus rate of return on a risk–free investment divided by the annualized monthly standard deviation. The greater the Sharpe ratio, the greater the risk–adjusted return. As calculated on the individual reports, the Sharpe ratio is calculated as follows; (Compound Annual ROR – risk free ROR (calculated from T–bills)) / Annualized Std. Dev. of Mo. ROR or Annualized Std. Dev. of Quarterly ROR.

24. What is the downside deviation?
    
    A value representing the potential loss that may arise from risk as measured against a minimum acceptable return. Downside deviation aims to isolate the negative portion of volatility.
25. What is a Drawdown?
    
    An investment is said to be in a drawdown when its price falls below its last peak .The drawdown percentage drop in the price of an investment from its last peak price. The period between the peak level and the trough is called the length of the drawdown period between the trough and the recapturing of the peak is called the recovery. The worst or maximum drawdown represents the greatest peak to trough decline over the life of an investment. The Drawdown Report presents data on the percentage drawdowns during the trading program´s performance history ranked in order of magnitude of loss.

    Depth: Percentage loss from peak to valley. Length: Duration of drawdown in months from peak to valley. Recovery: Number of months from valley to new high. Start Date: Month in which peak occurs. End Date: Month in which valley occurs.

26. What is WDD or Worst drawdown as calculated by Barclays?

    Drawdown = (1 – Valley VAMI / Peak VAMI) (X 100 for %)

    Example: Peak VAMI = 2000, Valley VAMI = 1500

    Drawdown = 1 – 1500/2000 = .25 or 25%

27. What is Average Recovery Time?

    The average time in a drawdown as measured from the previous peak to a new peak (New high ground). If the program is still in a drawdown, the calculation assumes that the drawdown is over.

28. What is VAMI?

    A Value Added Monthly Index (VAMI) table, is the industry standard for evaluating the performance of investment managers. It indicates the value a manager has added to an investment via a cumulative index and because it excludes non trading expenses such as tax, it can be used to compare investment managers around the world. The column headed "VAMI" within a table shows how an initial $1000 investment has grown over time.

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