In the managed futures space, you can’t get more than a handshake into a conversation with a manager without taking a look at their disclosure documents (if that far). These carefully crafted documents are written in eloquent legalese that can be a mess to wade through without the proper background or hand-holding, but in our opinion, understanding the terms therein is incredibly important.
A disclosure document, or DDoc, is a formal description of an investment strategy, detailing the terms and conditions of an investment, and signifies an agreement between the investor and the investment manager. This document is the cornerstone of the individual managed account structure, with the document laying out just how the CTA will trade the account and the client agreeing and authorizing the CTA to trade the account via the signature pages of the DDoc.
What will you see in your average DDoc?
- Program name and manager contact info
- Disclaimers (lots of them)
- Background of Company & Principals
- Brief trading / strategy description (not all inclusive)
- Risk factors to consider
- Discussion on Notional Funding and how it affects performance and risk
- Fee calculations
- Potential Conflicts of Interest
- Any Administrative, Civil, or Criminal Actions against the manager or recommended broker or FCM for the account.
- Past Trading Performance
These documents can be a beast to dig through, with the average length, in our experience, about 20-30 pages. If you’re finding yourself needing to sift through one of these legal hulks, there are a few things you should pay close attention to:
Description of Trading Program – While most D-Docs use only the most basic of language and are loathe to give away the ‘secret sauce’, there are still basics you need to make sure of in the program description. Are they technical traders or discretionary? Do they trade options at all? If so, there’s another set of risk. What sort of risk per trade do they take on? Any sector limits? The list goes on and on, and the more you understand what they are doing, the more comfortable you will be with the program during any tough times ahead. If you don’t understand what they are doing, how they are supposed to make money, and what environments are good for them from the D-Doc, find someone who does (and quick).
Fees- What sort of fees are you paying for the manager’s service, how often will they be taken from the account, how are they accrued, and more are laid out. As are any tack on fees such as a liquidation fee, up front sales charge, give up fees, and more.
Performance- Whatever you have seen elsewhere regarding performance should be thrown out in favor of what you see in the D-Doc. This is the official performance they are linking with their program via the D-Doc, and the performance which will be audited should the NFA audit the CTA. One important thing we look for are any special notes to the performance. Are the results actual client trading or proprietary in nature? Looking for risk adjusted rations like the Sharpe, MAR, and so on. You aren’t likely to find them in the D-Doc, where just the bare bones minimum requirement as far as data is provided. If you can’t some piece of data in the DDoc… well, there’s another reason to work with a broker.
Funding- What is the minimum investment level? And is notional funding allowed? Make sure you understand exactly what it’s going to take (and how much you’ll be risking) should you choose to invest in their program.
Conflicts of Interest- There are a myriad of ways a manager can find themselves in circumstances that compromise the integrity of a program. Trading proprietary funds and/or family funds alongside clients can emotionally charge decisions. There are also trade execution considerations to look at. Is there a strong connection to the executing broker? That may cloud their decisions. These conflicts may be listed, but not thoroughly explained… which brings us back to the broker advantage. They may be able to provide additional insight into these potential conflicts of interest, advising you on which ones are worthy of reflection.
Bottom line? DDocs are important. Read them. Read them thoroughly. And if you’re smart, get a broker to help you figure it out.