How Investors Lose 89 Percent of Gains from Futures Funds

thenews 2013.10.08 10:46

The pitch was enticing. At a time when the Standard & Poor’s 500 Index had suffered a decline of 41 percent in the previous three years, Morgan Stanley (MS) was offering its clients the possibility of some relief.

In a prospectus, the New York securities firm invited its customers to put their money into a little-known area of alternative investing called managed futures.

“If you’ve never diversified your portfolio beyond stocks and bonds, you should know about the powerful argument for managed futures,” the bank wrote. “Managed futures may potentially profit at times when traditional markets are experiencing losses.”

Morgan Stanley presented a chart telling investors that over 23 years, people who put 10 percent of their assets in managed futures outperformed those whose investments were limited to a combination of stocks and bonds, Bloomberg Markets magazine will report in its November issue.

Clients jumped in. During the decade ended in 2012, more than 30,000 investors entrusted Morgan Stanley with $797 million in a managed-futures fund called Morgan Stanley Smith Barney Spectrum Technical LP. The fund already had $341.6 million invested during the previous eight years.

Top fund managers speculated with that cash in a wide range of asset classes. In that period, the fund made $490.3 million in trading gains and money-market interest income.

No Gain

Investors who kept their money in Spectrum Technical for that decade, however, reaped none of those returns -- not one penny. Every bit of those profits -- and more -- was consumed by $498.7 million in commissions, expenses and fees paid to fund managers and Morgan Stanley.

After all of that was deducted, investors ended up losing $8.3 million over 10 years. Had those Morgan Stanley investors placed their money instead in a low-fee index mutual fund, such as Vanguard Group Inc.’s 500 Index Fund, they would have reaped a net cumulative return of 96 percent in the same period.

The “powerful argument” for managed futures turned out to be good for brokers and fund managers but not so good for investors.

In the $337 billion managed-futures market, return-robbing fees like those are common. According to data filed with the U.S. Securities and Exchange Commission and compiled by Bloomberg, 89 percent of the $11.51 billion of gains in 63 managed-futures funds went to fees, commissions and expenses during the decade from Jan. 1, 2003, to Dec. 31, 2012.

Fess: $1.5 Billion

The funds held $13.65 billion of investor money at the end of last year, according to SEC filings. Twenty-nine of those funds left investors with losses.

The $8.3 million loss in Morgan Stanley’s Spectrum Technical fund over a decade pales in comparison to an aggregate deficit of $1 billion in 29 Morgan Stanley and Citigroup Inc. (C) managed-futures funds in the four years ended on Dec. 31, the filings show. Those funds charged investors a total of $1.5 billion in fees.

Morgan Stanley and Citigroup merged their funds’ management in 2009; Morgan Stanley bought out Citi’s share in June.

“The big news here is, the fees are so outlandish, they can actually wipe out all the profits,” says Bart Chilton, one of five members of the Commodity Futures Trading Commission. Even though the CFTC oversees managed futures, Chilton says he hadn’t been aware of the effects of the high costs for investors.

“We absolutely need to do a better job of letting consumers know in plain English what’s going on,” he says. “Those numbers tell a story. It’s astounding.”

Little Noticed