We speak regularly with aspiring CTAs and those who recently started their program. This is an important part of our value as a database provider and asset raiser for our traders. More importantly, it is a benefit to our investment customers. After all, finding new talent with the ability to generate returns and learning about unique strategies is one of our primary roles as portfolio managers. Throughout these conversations, we see several questions come up almost every time, so I thought I would address the most common ones here:
When to launch your new program?
A program needs a minimum of one year of trading before it should be launched to the public. This provides data for what the monthly volatility looks like, that the program can make money, and gives evidence that the trader can manage a futures strategy. It does not, however, show how it will perform in different environments or through unexpected events that occur more frequently than “experts” would assume. These include a pandemic, a volatility explosion when two ETFs collapsed, and a bank failure caused by Fed policy designed to combat inflation.
What do investors seek in a futures program?
This will vary by investor, and many new managers will focus on achieving as high a return as possible. While everyone loves to make money, most initial investors are equally concerned with risk management and contained drawdowns. The first goal is to put up positive numbers each year. Returns targeted in the 20% range with 10% drawdowns are often ideal. Larger investors often use cross-margining and leverage to push smaller targeted returns higher but often do so with established programs. One needs to stand out from the crowd to get attention. Returns, unique stories or trading styles, and pedigree are some items that impact how much notice you will get.
Setting fees
The days of 2% management and 20% performance are no longer feasible in today’s markets for new offerings. In fact, outside of some exceptional programs, they do not seem viable for established ones either. The first customers to a program take a chance on a new business and an unproven strategy. They will look for (and deserve) a break on fees. 0% management and 30% performance is the highest you should expect at this stage. Fees often increase as returns and the number of customers go up. Quite simply, there is more supply of new CTAs than customer demand at this point of your evolution. While success might eventually make you upset that some customers pay less years from now, remember who provided the stepping stones to reach your current level.
Offerings separate accounts vs. funds
Managing a single fund structure may be easier, but I advise against it at the outset. When proving yourself, transparency is critical, as engaged investors want to see how you make money and manage your trades. It is also simple for them to add you to an already established account to “try you out” and see if you are a fit. Running a fund is expensive. Audit fees, administration, and accounting are just a few additional costs. Those dollars can be better spent on scaling your business, improving your infrastructure, and servicing your clients. Once assets reach a critical level and the CTA is proven, you can consider making your own fund or partnering with a managed account platform that offers the best of both worlds. We discussed this option in depth in a previous article.
Minimum investment size
Lower entry points make it easier for investors to give you a chance with limited risk. Therefore, it makes sense to start as low as possible. Different strategies might not lend themselves to small minimum investment sizes. These include directional programs that hold many positions at a time across multiple markets. Length of track record, trader pedigree, and uniqueness of the strategy within the futures space can overcome some of these hurdles. Over time, your minimum should adjust upward as you move from high-net-worth individuals to institutional clients. I think not forcing out original customers with this increase is essential. Still, sometimes, it is inevitable as the complexity of the trading adjusts to higher volumes and new ideas.
Marketing materials
At a minimum, every CTA should have a tear sheet that they distribute monthly, a disclosure document, subscription paperwork, and a presentation describing the strategy. The tear sheet should include monthly performance for all the years available, a short program description, and the trader’s contact information. Many will offer commentary on the previous month’s performance and the markets they trade. The due diligence questionnaire (DDQ) is a document that goes into significantly more detail on the operation, the principals, and the back-office support, amongst other things. It is an appreciated element that should be available once you get over $25 million in AUM, if not sooner.
Choose where to trade
Most FCMs in the futures space will engage in “give-up” transactions where the CTA can trade at RJO or ADMIS even if their customer is at StoneX. The manager simply trades everything in one place, and then trades are sent or “given-up” to the location of their customer accounts. Interactive Brokers is the notable exception to this arrangement. This simplifies the structure of a new company and allows your investors to keep their accounts intact across all their investments for a small additional fee. Ideally, this give-up costs 25 cents or less per trade, but if the volume of trading is low or you are new to the industry, they might push this up initially to be re-negotiated later.
Conclusion
Running a successful trading operation is difficult; great ideas are just one piece of a complicated puzzle. For those who succeed, it can be rewarding in financial and personal fulfillment terms. It is not for the faint of heart, however, as each day can bring new surprises, and losing money for other people can be stressful. They are helping investors retire early or protecting them when everything else in their portfolio struggles can ultimately make it all worth it.
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