The Commodity Futures Trading Commission is investigating the high fees charged to investors in the $337 billion managed futures market.
CFTC Commissioner Bart Chilton says the agency initiated the inquiry after Bloomberg Markets magazine reported in its November issue that 89 percent of the $11.51 billion profits of 63 managed futures funds was consumed by commissions, fees and expenses.
“Of all a regulator’s duties, first amongst those should be safeguarding consumers,” Chilton says. “That includes highlighting, and potentially banning, excessive fees that can gobble up profits.”
The CFTC probe comes as a U.S. Senate committee today sent a letter urging the agency to work with the Securities and Exchange Commission to study ways to provide clearer disclosure of high fees charged to retirement accounts invested in managed futures funds.
``As Chairman and member of the Special Committee on Aging, we take very seriously our responsibility to safeguard the investment security of older Americans,'' Chairman Bill Nelson, a Florida Democrat, and Elizabeth Warren, Democrat from Massachusetts, wrote to CFTC Chairman Gary Gensler.
Chilton, one of four CFTC commissioners, says regulators should require managed futures fund managers to be more transparent about the cumulative effect of fees on investors over time.
Fees, commissions and expenses in managed futures funds often cost customers a large majority -- or all -- of their gains, according to filings with the Securities and Exchange Commission. Some managed futures funds charge as much as 9 percent of assets annually.
“The problem is I don’t think investors understand this,” Chilton says. “We need to do something about that.”
Chilton, a Democrat who has planned to step down by the end of 2013, says he may stay longer. President Barack Obama hasn’t nominated Chilton’s replacement. The commission, which is supposed to have five members, could be down to just two, Democrat Mark Wetjen and Republican Scott O’Malia, if Chilton departs. Republican Jill Sommers left in July and Gensler's term expires at the end of the year.
“I’m hopeful this inquiry will assist the agency in ensuring that customers are aware of all the circumstances before they invest,” says Chilton, who previously said he was astounded when he learned of the effect of the fees on investors. “I’ve asked the staff to review the various fees that are charged.”
Once started, a probe continues, even if a commissioner steps down, Chilton says. “The inquiry won’t end when I leave, and I’m not leaving for a bit,” he says.
The CFTC has the authority to demand confidential information from the industry without subpoenas.
“This is welcome news,” says James Cox, a securities law professor at Duke University in Durham, North Carolina. “The question is whether the CFTC has the gumption to follow up and hold the industry accountable. This regulator has been slow to shine the light on this. This shows the power of the pen in making the financial system accountable.”
Steve Hinkson, a spokesman for the Managed Funds Association trade group in Washington, declined to comment on the probe. “MFA does not comment on regulatory inquiries,” he says.
Managed futures funds buy and sell contracts to speculate on up and down price moves in stock indicies, interest rates, currencies, metals, oil, natural gas and more.
Conflict of Interest
The Bloomberg Markets article, “Fleeced by Fees,” uncovered conflicts of interest between fund managers and investors.
Bloomberg Markets reported that one fund, $503.1 million Grant Park Futures Fund LP, managed by Dearborn Capital Management LLC, allowed its president, David Kavanagh, to place undisclosed personal bets ahead of, and sometimes opposite to, the fund’s trades.
“Mr. Kavanagh may even be the other party to a trade entered into by Grant Park,” according to the Chicago-based fund’s April prospectus.
Grant Park has since banned that practice, according to a regulatory filing on Nov. 18.
“The principals and employees of the general partner, as a condition of their employment, are prohibited from trading futures contracts for their own account,” the fund wrote.
Grant Park reported a net investor loss of $68.6 million in the decade ended on Dec. 31, after subtracting fees and commissions of $427.7 million. Fund investors lost an additional $46.9 million in the first nine months of 2013, after fees and commissions of $27.2 million. The fund is marketed by UBS AG.
Kavanagh, president of Dearborn Capital, didn’t respond to requests for comment.
The Bloomberg Markets story reported that New York-based Morgan Stanley brokers had persuaded more than 30,000 clients to invest $797 million in the firm’s Spectrum Technical Fund over the past decade. The sales pitch was that managed futures can rise when traditional markets, like stocks or bonds, fall.
The fund accepted investments of as little as $2,000 for retirement accounts.
The Morgan Stanley fund earned $490.3 million in trading profits and interest income over the ten years ended Dec. 31, 2012. All of those profits, and more, were eaten up by $498.7 million in commissions, fees and expenses. Investors lost $8.3 million over the decade.
Over the same period, investors in a low-fee index fund like the Vanguard Group Inc.’s 500 Index Fund reaped a net cumulative return of 96 percent.
Fees continued to wipe out profits for the Spectrum Technical fund in 2013, Morgan Stanley SEC filings show. The fund earned $392,146 trading in the first nine months of 2013. ITS investors lost $8.5 million after paying $8.9 million in fees and commissions, the filings show.
“Managed Futures are presented to suitable investors,” Morgan Stanley spokeswoman Christine Jockle says. Such funds are part of a diversification strategy, and the bank fully discloses its fund expenses, she says. The Morgan Stanley fund outperformed the Standard & Poor’s 500 Index in 2008, Jockle says.
The Morgan Stanley fund accepted investments of as little as $2,000 for retirement accounts, while Grant Park's minimum for IRA accounts is $1,000. That marketing effort concerned the Senate Aging Committee.
``We are very concerned about the potential impact these fees could have on the retirement security of the Americans who invest in these funds,'' the senators wrote to Chairman Gensler, citing the Bloomberg Markets story.
``We request that the CFTC confer with SEC officials and study what specific disclosures and additional investor information might improve the opportunity for investors in all managed-futures funds to retain more of the substantial profits the industry is making -- and keeping -- through what appear to be unreasonably high fees, commissions, and expenses.''
Chicago-based CME Group, the world’s largest futures exchange by volume, touted the long-term performance of the so-called BarclayHedge CTA Index to persuade investors to put some of their money into managed futures funds. That document shows a 29-fold gain by fund managers from 1980 through 2012. The index is incomplete. It doesn’t deduct billions of dollars in fees charged by funds.
The CME had displayed that document on its website since 2009. When the Bloomberg Markets article was published, the CME took it off the site.
“It was removed as we regularly update materials on our website,” says Laurie Bischel, a CME spokeswoman.
The index of 582 commodity trading advisers is compiled by a small company in Fairfield, Iowa, with no connection to London-based Barclays Plc.
The index isn’t investable; it’s actually just a chart. It relies on voluntary reports from fund managers, who can provide whatever data they choose, and can stop reporting at any time. The BarclayHedge index fell 2.5 percent over the first ten months of 2013 -- and that investor loss doesn’t reflect hundreds of millions of dollars in fund fees.
Chilton says managed future funds’ multiple layers of charges unfairly stack the odds against investors.
“I’m hopeful this inquiry will assist the agency in ensuring that customers are aware of all the circumstances before they invest,” he says.