In the Future IBs and Financial Advisors Compete Head to Head
By Mark Melin | Author High Performance Managed Futures and division director at PFGBest.
In my last article, I mentioned that managed futures could grow to a $3 trillion industry rather quickly. This is an admittedly optimistic projection, but then I’ve been witnessing some very interesting developments that make this projection seem more plausible – and most of this is coming from the equity world.
There are several well-known financial advisor-based firms that are preparing to descend on the managed futures industry with a force our industry has never seen. Essentially, these household names have figured it out. Managed futures is uncorrelated to the stock market at the performance driver level. Their investor client’s don’t need to understand this, but now that the equity world gets it they can start marketing investment portfolios not entirely tied to the performance of the stock market. I’ve heard of some marketing tests where sophisticated investors are responding well to this message, particularly in a debt-filled economic environment. Where there is opportunity you can bet Wall Street will follow.
There are those right now who are setting up a managed futures mutual fund distribution channel, converting existing CTAs into mutual funds and then distributing them through equity channels. While some of this activity depends on how the CFTC rules on managed futures mutual funds, demand for the investment in the equity world continues to grow – and this demand will be met, it is just a matter of how. This has potential to explode our industry, but how does it impact the traditional managed futures IB?
The growth in managed futures points to increased competition coming from the traditional Wall Street financial advisor. They question is: how can a managed futures introducing broker (IB) who offers clients direct managed futures account navigate this threat?
The biggest weakness many financial advisors have when discussing managed futures is their lack of understanding the asset class and the account structure they offer does not include investor protections. On the upside the limited liability structure offered is a theoretical benefit (read chapter 11 for more on this topic).
There are five key points advisors must understand in order to carry on an intelligent managed futures conversation, which were outlined when Northwestern University has a four hour educational course on the topic this March 19. IBs must understand these key points and communicate them properly.
The IB that succeeds in the future may have these characteristics in common:
1. Understanding of Trading Strategies: Most financial advisors don’t understand the critical difference in strategies and how this impacts risk. Page 80 starts to briefly explain these strategies, and in whole chapter four of the book explains managed futures in easy to understand and entertaining terms. In the future successful IBs will leverage their unique knowledge of trading strategies and how these strategies correlate with one another, as discussed in chapter nine, and how to build portfolios using these strategies, as outlined in chapter ten.
2. Ability to Properly Communicate: Most financial advisors talk about portfolio diversification using traditional asset classes, but as is mentioned on page 10, Nobel Prize winners have pointed out traditional stock diversification is impossible. IBs need to understand how this, along with specific performance benefits of a direct managed futures account mentioned on the next page 11, work to differentiate them from a traditional financial advisor. Smart IBs need to understand how to speak the language of managed futures portfolio diversification and utilize appropriate portfolio building methods that don’t mask hidden risk. Consider page 163 to understand strategy risk, and if you are building managed futures portfolios using a traditional correlation matrix, read on to page 167 and understand how most correlation analysis is faulty. IBs need to intelligently explain to investors why managed futures makes sense, how it works and how a diversified portfolio can be developed.
3. Understanding of Direct Account Benefits: They understand how different account structures impact transparency, liquidity and performance, which starts on page 83 with industry investor protections detailed through chapter five. IBs need to understand know how to address client issues regarding margin and leverage, which starts on page 204.
4. Risk Management: IBs need to have a risk management plan in place for their clients and understand how to manage CTA risk using a number of tools, including margin to equity indicators as outlined in chapter twelve. The asset class transparency and the ability to manage margin risk is a unique point of differentiation that should be touted in a direct managed futures account structure.
5. Wide Variety of Product Offerings: A key weakness of most financial advisors is they offer a small number of managed futures programs and cannot properly build a diversified managed futures portfolio. IBs need to seize on this and properly develop diversified portfolios utilizing online tools. With small accounts, an arena where managed futures mutual funds will likely compete significantly, IBs might consider touting the appropriate trading systems investments – particularly trading systems that are appropriate for investing on a drawdown and “selling” when they reach a statistical high point. The concept of investing in managed futures on a drawdown is touched on in chapters three and ten, and this concept can extend into systems as well.
6. Technology: Successful managed futures IBs will have adopted advanced technical systems that empower their clients. This includes Internet applications for online portfolio building, graphical account statements and even computer-based managed futures account opening and electronic processing of D Docs. Our industry isn’t entirely there yet, but some of the early efforts are interesting and moving in the right direction.
There are significant opportunities and challenges as the managed futures asset class grows in popularity. The book High Performance Managed Futures was designed to handle some of the educational workload with investors and also strongly confront traditional Wall Street, which has essentially ignored the industry for too long.
IBs can purchase the book by following this link: http://amzn.to/jKQvsa
Mark Melin, author High Performance Managed Futures and division director at PFGBest. If you have questions or comments regarding any of the items in this article, contact Mark at mmelin@pfgbest.com. To register for the upcoming Northwestern University managed futures course, visit the Northwestern Site at http://bit.ly/g0VY6R or www.Go2ManagedFutures.com/Northwestern.