Years of investment marketing tell us that a fund’s expense ratio is the most important characteristic we should look for in our asset selection. So, it is unsurprising that the first question I often get is, “How do you get paid if I open an account with you?” The question I get less often is, “What would I receive in exchange for that payment?” Of course, both are great questions and necessary when considering a new advisory relationship. But first, let’s address the fees associated with futures traders.
Mutual funds and ETFs place their overall cost upfront on their marketing materials. This makes sense for an S&P 500 index fund tracking a relatively static index. After all, stock selection is not made by the company trading the product. Positions can also be held for long periods, as they should, to avoid tax consequences and additional fees, which eliminates some trading costs. On the other hand, futures contracts expire, so rolling positions is necessary, which adds expense. While simple index-tracking CTAs exist, most investors look for specific characteristics in these types of programs. Amongst the top attributes are returns, risk management, diversification, and access to different markets than their traditional investments. All of these factors, done well, can add costs. Let’s take them one by one:
- Returns – Result from large winning positions or many profitable positions. Either requires more trading to buy and sell each one.
- Risk management – This is often driven by a higher frequency of trading as more volume means more opportunities and often smaller gains and losses per trade.
- Diversification – This is often considered the “Free lunch” in risk management, but more sectors traded means more opportunity and more time, effort, and systems to track and trade.
- Access to different markets – The cost structure of trading an oil or copper contract is affected by a different regulatory body and exchanges than stocks or bonds. Efficiency is gained using margin instead of the full funding required with other asset classes.
All of the things above require more effort and a unique skill set compared to many traditional asset classes. Furthermore, to provide uncorrelated returns, one must create a unique approach to markets that is proprietary and difficult to replicate. Most managers, therefore, charge some management fee. This cost often goes to pay their overhead, which includes systems and employees. Truly, they prefer to make performance fees which get paid when they surpass their all-time high-water mark. This is ideal for both the trader and the investor. Newer managers, especially some established ones, may offer an incentive fee-only structure.
So why would you use a futures broker?
Looking at return profiles and choosing the one that looks right can work occasionally, but it can overlook key issues. Take this year, for example, if you want to find the highest returning managers for 2022. Invariably, you would end up looking at trend-following managers. These strategies provide valuable diversification, but trends were particularly strong this year, yielding good results across the board. So, how would you identify the best one? How might you identify advantages and disadvantages moving forward? Other common things we see across managers include a trading style change at some point, reduced leverage, added systems to improve diversification, or key employees leaving the firm. It does not take many errors at the beginning stages of an investment to lose significant sums of money that could have been avoided by simply accessing advice early.
On an ongoing basis, a broker monitors the accounts, sees if trading matches the strategy description, watches margin levels, notifies customers of any changes in the trading company, and also points out things that have gone well or poorly and why. Most of our customers are high net worth individuals who either work in a well-paying job or retired with considerable wealth. It does not make sense for a doctor or a lawyer to spend their little free time (or working hours) watching the daily activity of their account. While a retired person might have more time, I imagine they dreamed more of their daily golf round than their time in front of a screen watching market quotes. Lastly, some firms provide tools to help you monitor your account; for IASG, this includes Insight, our proprietary system, which is provided to our customers free of charge to simplify their portfolio tracking.
So how much does this advice cost?
Compensation derives from two places. A percentage of the manager’s fees is the first. The customer would pay this amount even if they went directly to the trader, so it is not an additional fee. Furthermore, some managers will offer a variable compensation structure. Relationships with managers help us determine who is open to this and how it might benefit our customers. Trade-based commission is the second way we are compensated. This includes a small markup from the institutional rate the FCM charges us. Daily statements display all these fees, and all manager billing is tracked in Insight for full transparency.
Lastly, one might ask, “Are all futures brokers the same?” To this, I would say emphatically not. Like any industry, we have some that give everyone a bad name. I believe that the top of the industry shares several characteristics. Honesty is, of course, the most important. While everyone says they share this trait, watch for how open they are about fees. Look at our site to see the average trade commission to see if you are well above the average. Good advisors will not push you into specific managers. Instead, they will listen and try to guide you toward the ones that match your goals. Advisor knowledge of strategies and the people behind them shows expertise. This is often gained through extensive conversations, industry events, and networks that share information. Most of the best brokers work with each other, even if they are competitors. Lastly, communication is key. Markets and circumstances change quickly. Knowing that someone will quickly pick up your phone call or answer an email provides peace of mind. After all, we all work hard for our money. We want someone who cares about our savings as much as we do.