What is a Commodity Trading Advisor (CTA)?

There are a myriad of financial professionals that most people are familiar with like CPA (certified public accountant), CFP (certified financial planner) and CFA (chartered financial analyst). But how many people know about a CTA (commodity trading advisor)?

Who is a CTA?

A CTA is a financial regulatory term for an individual or a business entity that provides advice and services related to trading futures and futures options contracts.

While the name “Commodity Trading Advisor” implies that a CTA will simply provide advice, the reality is that CTAs directly trade futures contracts on behalf of their clients. Other ways CTAs can provide services is through newsletters or trading groups.

A CTA is required to pass the Series 3 exam and register with the NFA (National Futures Association). In order to maintain membership, CTAs must adhere to strict regulatory requirements including an annual report, current disclosure documents as well as many others.

How much does it cost to invest with a CTA?

The fees for this service are typically a management fee, which is a percentage of the total assets under management, and a performance fee which is only assessed on trading profits. 

Fees are determined by the individual CTA, but the industry standard fees are a 2% management fee and a 20% performance fee. However, many CTAs (including myself) are ditching the management fee and only charging for performance. This way the CTA only makes money if the client makes money.

How do CTAs generally trade?

While there are no specific rules and regulations regarding specific trading strategies, CTAs largely employ systematic trading strategies that are largely trend following and mean reversion. 

Systematic trading involves development of algorithms that evaluate the behavior of a commodity’s price and attempt to enter a trade with a mathematical probability of profit. 

Trend following is a specific trading strategy that looks to buy a commodity when the price is going up and sell a commodity when price is going down. 

The opposite approach would be mean reversion, which would look to buy a commodity when the price is going down and sell a commodity when the price is going up. 

Which strategy to use is dependent on the individual commodity and the current market conditions.

What products to CTAs trade?

Historically, as the name suggests, CTAs trade futures on physical commodities like grains, metals, meats, energies and softs. However, CTAs are now commonly trading futures on financial instruments such as equity indexes, treasuries and currencies.

Each individual CTA will have a specific trading program that defines what products are traded.

What kind of returns can a CTA generate?

The performance of CTAs is highly variable and dependent on the individual CTA. More important than overall returns are risk adjusted returns. In other words, how do the returns relate to the drawdowns?

Some common metrics used to evaluate risk adjusted returns are Sharpe ratio, Sortino ratio, Calmar ratio and return divided by maximum drawdown. The specifics for these metrics are for a future article.

More important than outright returns is that CTA returns are typically not at all correlated with the stock market. When thinking about a holistic investment portfolio, adding a CTA can diversify the portfolio and reduce risk exposure to the stock market.

The most popular database for CTA performance is Autumn Gold. Here you can find top rankings, individual CTA performance and capital requirements.

Who can invest with a CTA?

While there are no exact requirements, typically CTAs service accredited investors. Accredited investors must meet one of the following:

• Annual income that exceeds $200,000 per year for the last two years

• Net worth of $1,000,000 excluding the primary residence

CTAs are required to conduct a due diligence on prospective clients to determine suitability for trading futures. Futures trading is considered high risk and the client must have substantial additional resources outside of the capital used to trade futures.

Through this due diligence a CTA can accept a non-accredited investor as a client provided that they are determined to be suitable.

Additionally, there is a minimum investment requirement to participate in a trading program. This minimum is set individually by the CTA and can range from a few thousand dollars to a few million dollars. 

What is the process of investing with a CTA?

One major difference between a CTA and many other financial advisors and fund managers is that CTAs are prohibited from accepting funds in their names. Clients open futures accounts themselves and then authorize the CTA to trade the account on their behalf. The CTA never takes possession of client capital.

The process of investing with a CTA is fairly straightforward and largely involves moderate paperwork:

• Open a futures brokerage account in the client’s name

  • Client will do this independently

  • Client will directly fund this account

• Due Diligence Questionnaire

  • CTAs are required to collect information on the prospective client’s financial situation to determine suitability through a direct questionnaire

  • CTAs are not required to verify the information provided

• Disclosure Document

  • CTAs are required to obtain NFA approval for their Disclosure Document prior to providing it to clients

  • Disclosure Documents have specific requirements to achieve NFA approval

    • General risks of trading futures

    • Specifics of the trading program used by the CTA

    • Fees

    • Conflicts of Interest

    • CTA Performance

• Advisory Agreement

  • Specific to CTA and individual client

  • Defines exact fee structure (can override Disclosure Document)

• Third Party Trade Authorization form

  • Specific to the brokerage the client is using

  • Allows the CTA to make trades on the client’s behalf

Once all of these forms are completed and the account is funded, the CTA can begin trading on the client’s behalf. The CTA provides periodic statements (monthly or quarterly) on the performance of the account.

For individuals of appropriate means, a CTA account can be a worthy addition to the investment portfolio. However, consider that futures trading involves substantial risk of loss and only risk capital should be used in futures trading.