When launching their programs, managers in the futures space are faced with a dilemma. First, they need to choose a trade level. This is an easy process for an equity manager as they often trade 100% of the cash available and sometimes decide to use leverage. However, ALL futures contracts already have the leverage built-in, so the question for them is how much to de-lever.

Take manager ABC. He trades his own account very aggressively and routinely has drawdowns of 20% but can make 60% in an average year. He recognizes that this might be uncomfortable for investors. He, therefore, decides to target a 15% return with 5% drawdowns and even offer a conservative version. The chart below shows all three programs, which are all actually the same program.

Trade level$100k$200k$400k
Average margin40%20%10%

Trades, in this case, are made in unit sizes. The conservative portfolio would get one contract per $400k and the aggressive one contract per $100k. If both had a 2% management fee, the conservative investor would pay $6k more per year for the same program. The “return on cash” would be exactly the same.

Asking questions about margin to equity, how trade levels were chosen, and comparing managers based on the return on cash can help investors made better decisions. In this case, the conservative investor could simply invest in the aggressive program and keep $300k in his bank account. Not a bad deal.


Photo by Bram Kunnen on Unsplash