Understanding the concept of notional funding is helpful, but it’s even better to get practical tips for using it. If this is the first time you’re hearing the term, you can catch up in our previous post, here. For tips on using notional funding, we turn to Alan Zenk, President of CTA Services, who works with CTAs every day to provide back office support. With the knowledge gained from working day in and day out with CTAs, Zenk recently provided tips investors might consider when it comes to notional funding that is definitely worth sharing:
If you’re new to the futures industry and are considering notional funding for your managed accounts, here are some pointers:
1 Don’t overdo it. Using more than 50% notional funding isn’t for the faint of heart. Your CTA usually reserves the right to refuse to allow you to use notional funding if the CTA believes you don’t have enough experience investing or don’t have the net worth appropriate to the leverage you’re applying to your account.
2 Consider margin requirements in setting notional funding levels. If your CTA’s typical margin to equity ratio is 40% or more and you’re at 50% notional funding, you could find yourself getting margin calls on relatively minor drawdowns. You don’t get much time to cover margin calls, so a temporary loss could be locked in for you when an FCM offsets your losing position because they don’t hear from you quickly enough.
3 Factor in drawdowns and correlations to other managers in your portfolio. To protect yourself, it’s worth a careful analysis of worst historical drawdowns and correlations across all managers in any portfolio you’re putting together. Make sure that when bad things happen, they don’t tend to happen to all your managers at the same time. Similarly, it’s better to build a mix of managers who make money in different kinds of markets for different reasons to smooth out the return stream. Notional funding can play an important part in structuring the mix exactly the way you want it.
4 Get help from an experienced broker you trust. Some CTAs are better candidates than others for notional funding. For example, a meats trader that only uses 5% to 10% margin and trades once or twice a quarter might be a good candidate, while an S&P option trader that deploys a variety of strategies in a single account and trades every day might not be ideal. A good broker has been around long enough to have learned valuable lessons and can help you use this leverage tool appropriately.
Who better to ask about notional funding than someone who has been working with CTAs for more than a decade! We especially like the last tip – as one of the largest independent introducing brokers in the Managed Futures space. Click here to learn more about us and our history.