In this article, we compare CTA vs hedge fund. Read on to know what is a CTA and what is a hedge fund, and the difference between the two.
The labeling of funds, particularly that of the “Hedge Fund,” is a topic that is often surrounded by confusion.
Many clients lack a practical understanding of the hedge-fund universe, which is often misrepresented in the media.
As a result, the value of hedge funds is not fully appreciated in the context of diversified portfolio construction and alternative investments.
Despite being a common term in the financial industry, Commodities Trading Advisors (CTAs) are often misunderstood, even by professionals in the field.
It is important to define the terms “CTA” and “Hedge Funds” before discussing their relationship.
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CTA vs Hedge Fund: What Is A Hedge Fund?
The term “hedge” refers to the act of managing or reducing risk. Within the framework of a fund, a manager can utilize various techniques to accomplish this objective.
Essentially, the manager can allocate capital or adopt a position that is opposite to his speculative position, thereby enabling him to take both sides of the same wager.
The method of achieving this depends on the type of fund being used. Techniques such as short-selling, cash, swaps, options, FX, commodity futures, or any other permissible technique in accordance with the fund’s regulations may be utilized.
Hedge funds possess the capability to generate dynamic or “absolute” returns by implementing strategies that are typically beyond the scope of conventional long/short funds. These strategies allow hedge funds to continuously minimize the potential for losses.
It is a common misconception that hedge funds are inherently aggressive or risky. However, this is not necessarily the case.
A hedge fund that adheres to its theme would typically exhibit lower levels of aggression and risk-taking compared to a conventional long/short fund. This is because such a fund has the ability to proactively safeguard itself against potential losses.
There exist hedge funds that are highly aggressive in nature and pursue ambitious returns at the cost of taking on a significant amount of risk.
It is important to note that there exist hedge funds, which are absolute return funds that prioritize consistency and stability over high-risk, high-reward investments.
These funds aim to provide investors with a low-volatility experience, minimal correlation to market trends, and a gradual, yet consistent, rate of return.
Some hedge funds do not actually hedge their investments, and instead take a long-only position in equities. They use their hedge fund status to take on high levels of leverage in order to try and achieve maximum returns.
Currently, relying solely on the term “Hedge Fund” may not offer sufficient information to make informed decisions when constructing a portfolio.
Hedge funds utilize a wide range of strategies and techniques, making it difficult to determine which one aligns with your investment goals without examining them closely.
Assessing the performance of investment funds can be challenging due to the various categories they fall under, such as long/short, market neutral, event driven, and arbitrage.
However, analytical ratios and fundamental mathematical calculations can help in evaluating their performance. Fortunately, fund distributors provide this information in their literature to assist investors in selecting the appropriate fund.
Hedge funds are a popular investment vehicle among a diverse group of individuals, typically classified as “professional” or “accredited” investors.
These investors can range from large institutions, corporate treasuries, and private banks to individual investors. In the past, hedge fund investments were only accessible to the ultra-wealthy due to the high minimum investment requirements ranging from 100,000 to 10,000,000 USD.
However, with the emergence of personal portfolio bonds offered by regulated life insurance companies, even small investors can now take advantage of the dynamic returns generated by hedge funds with a significantly lower initial investment, sometimes as low as 10,000 USD.
As alternative investment instruments, such as those found in databases like EurekaHedge, offer diversification and potentially higher returns, hedge funds are becoming increasingly popular among regular investors. As a result, they are being included in more and more investment portfolios.
CTA vs Hedge Fund: What Is A Commodity Trading Advisor?
A commodities trading adviser, also known as a CTA, is a person or company that offers customized advice about options on futures, the purchase and sale of futures contracts, and retail off-exchange currency contracts or swaps.
It is necessary by the National Futures Association (NFA), the self-regulatory body for the derivatives sector, that advisors who provide such advise be registered as CTAs.
The Grain Futures Act, which regulated futures trading and was enacted in 1922, was named after its namesake commodity. Later on, in 1936, it was superseded by the Commodity Exchange Act, which imposed stricter regulations on the trading of commodities and futures and mandated that some types of trade take place only on licensed exchanges.
In order to make changes to the original Commodity Exchange Act, Congress passed the Commodity Futures Trading Commission Act of 1974 in 1974.
The name “commodity trading advisor” (sometimes written as “CTA”) was coined as a result of this act, which also led to the establishment of the Commodity Futures Trading Commission (CFTC).
When making an investment in commodities, you will often be required to utilize a big amount of leverage. As a result, you will need a greater degree of knowledge in order to trade correctly and prevent the possibility of incurring major losses.
The CFTC has, throughout the course of time, steadily increased the number of standards that must be met in order to qualify as a CTA. In order to manage CTA registration and guarantee that registered members followed with CFTC laws and NFA standards, it formed the NFA as the organization that would be in charge of the NFA.
A commodity trading adviser, or CTA, is a kind of financial advisor that specializes in advising clients on matters relating exclusively to the trading of commodities.
In order to receive the CTA registration, candidates are required to achieve various standards for their level of expertise, one of which is to pass the Series 3 National Commodity Futures Exam. If advisers can demonstrate that they meet certain requirements, they won’t have to register with the CTA.
How to Become a CTA
In order to offer guidance on commodities trading, it is typically necessary for a company or individual to become a registered Commodity Trading Advisor (CTA) with the National Futures Association (NFA), with a few limited exceptions.
Individuals who register as a Commodity Trading Advisor (CTA) solely with the Commodity Futures Trading Commission (CFTC) are authorized to provide general trading advice, publish newsletters, and offer recommendations.
However, they are not permitted to manage clients’ funds. The specific category of call-to-action being referred to is commonly referred to as an educational call-to-action
In order to actively manage client funds, CTAs are required to register with the NFA as a CTA. It is important to note that registration as a Commodity Trading Advisor (CTA) can only be done through the Commodity Futures Trading Commission (CFTC) and not through the National Futures Association (NFA).
Passing The National Commodity Futures Exam
Typically, individuals seeking to become a CTA must first pass the National Commodity Futures Exam, also known as the Series 3 exam, which is regulated by the Financial Industry Regulatory Authority (FINRA).
The National Futures Association (NFA) was responsible for developing the exam. Unlike several other licensing exams, the Series 3 exam does not mandate a sponsor for candidates to appear for the test.
To register for the FINRA exam, you can simply visit their website and complete the application process. This involves filling out the necessary paperwork and submitting a fee of $140.
Upon successfully passing the exam, you are granted a two-year window to complete the registration process as a Commodity Trading Advisor (CTA) with the National Futures Association (NFA).
The examination is divided into two parts and comprises of 120 multiple-choice questions. To successfully pass the test, candidates must obtain a minimum score of 70%.
The exam will cover fundamental concepts related to futures and options markets, such as hedging, speculating, margin requirements, types of orders, spreading, and market regulations.
Typically, it is suggested that individuals allocate 60 to 80 hours of study time to adequately prepare for the Series 3 exam. However, it is important to note that individuals who possess prior experience trading futures and options may require less time to adequately prepare for the exam.
It is important to keep in mind a few key points regarding the upcoming exam. The Series 3 device employs a rounding down mechanism that converts any decimal percentage value to the nearest whole number that is lower than the original value.
To clarify, scoring a 69.9% on the Series 3 exam would result in a rounded down score of 69%, which unfortunately falls below the passing threshold. Moreover, in the event of failure, you will be required to wait for a period of 30 days before being eligible to retake the exam.
In the event that you are unsuccessful in passing the Series 3 exam on three separate occasions, a waiting period of 180 days will be imposed before you are eligible to take the exam again. This waiting period will apply to each subsequent attempt after the third failure.
Register With The National Futures Association (NFA)
In order to become a registered Commodity Trading Advisor (CTA), it is a requirement to hold membership with the National Futures Association (NFA).
To obtain membership with NFA, you may submit an application for membership through their online portal and remit a non-refundable payment of $200.
In order to become a Commodity Trading Advisor (CTA), the initial step is to appoint a security manager who will facilitate secure access to the National Futures Association’s (NFA) online registration system. In addition to other requirements, it is necessary to fulfill the NFA’s online Form 7-R, annual questionnaire, and remit CTA membership dues.
To retain your CTA status, it is necessary to pay your annual dues to the NFA. In addition to other requirements, it is necessary to fulfill the annual questionnaire, annual registration update via NFA’s online registration system, and the self-examination questionnaire as mandated by NFA.
What Are The Advantages Of Being A Commodity Trading Advisor (CTA)
The CTA offers clear advantages for those seeking or providing guidance on commodities trading.
To offer guidance on trading commodities, an individual or company must obtain registration as a Commodity Trading Advisor (CTA) from the National Futures Association (NFA), unless they qualify for one of the exemptions.
If an individual or firm has given advice to 15 or fewer people in the last 12 months and has not held themselves out to the public as a Commodity Trading Advisor (CTA), they may not be subject to certain regulatory requirements.
The CFTC-registered individual or firm provides CTA-related advice that is incidental to their primary business or profession.
The guidance given lacks the basis of expertise or tailored consideration for a customer’s commodity interest account.
Individuals who possess the designation will have the opportunity to pursue their desired business ventures. Furthermore, CTAs have the ability to generate revenue through both a management fee and a performance fee.
In the world of finance, it is customary for a Commodity Trading Advisor (CTA) to charge a management fee of 2% on all assets under their management. Additionally, a performance fee of approximately 20% is often charged on any new money that the CTA has generated.
Typically, CTAs (Commodity Trading Advisors) require a minimum investment of $10,000. To clarify, calls-to-action (CTAs) have the potential to generate a substantial amount of revenue.
Customers can be assured that their advisor is competent and has likely cleared a FINRA-conducted examination.
Furthermore, it is advisable for clients to verify the registration of their chosen CTA with both the Commodity Futures Trading Commission (CFTC) and the National Futures Association (NFA). Potential clients have the option to search for any disciplinary records pertaining to their CTA on the NFA website.
It is imperative for CTAs to furnish their clients with monthly account statements and keep their disclosure documents up-to-date. These documents should comprehensively outline the advisor’s trading methodology, performance markers, investment risks, and fees.
CTAs vs. Money Managers
Money managers are professionals who are responsible for managing investment portfolios on behalf of their clients. They are also commonly referred to as portfolio managers or investment managers.
Similar to CTAs, these tools offer tailored recommendations and oversee investments. The majority of individuals who manage money possess the esteemed chartered financial analyst (CFA) certification, which signifies their expertise in making informed investment choices.
Typically, financial advisors prioritize selecting stocks and bonds when constructing investment portfolios for their clients, with less emphasis on commodities or futures.
Money managers typically receive compensation in the form of fees for executing transactions on behalf of their clients. In addition, clients typically compensate their money managers by paying a percentage of the total assets under management.
Money managers are often entrusted with a fiduciary responsibility to prioritize the best interests of their clients. Unlike CTAs, they are not required to furnish an equivalent degree of documentation.
The primary responsibility of a money manager is to assist clients in achieving their financial objectives. This involves executing trades on behalf of clients, monitoring performance, and submitting reports to regulatory bodies on their clients’ behalf.
CTAs, or commodity trading advisors, specialize in providing guidance on commodities and futures trading to their clients. They also help their clients achieve their financial objectives.
CTA vs Hedge Funds: The Differences
A Commodity Trading Advisor (CTA) is an entity that provides advice to others on the value of buying or selling futures contracts, retail off-exchange forex contracts, options on futures, or swaps, in exchange for compensation or profit.
The National Futures Association (NFA) is a self-regulatory organization that oversees and regulates the futures industry in the United States.
It was established in 1982 and is responsible for enforcing ethical and professional standards, providing education and training to industry professionals, and protecting investors from fraudulent activities.
In essence, a CTA is typically a Managed Futures Strategy that is structured as a hedge fund, meaning that in the majority of cases, the two terms are interchangeable.
Engaging in physical commodity trading can be a costly endeavor, and it may also present challenges related to illiquidity and delivery that can hinder trading strategies over time.
Futures contracts offer a practical solution to address these concerns while also enabling individuals to engage in commodities markets through the use of derivatives.
In a somewhat perverse manner. CTA strategies have a broad scope beyond trading in the Commodities markets. It is common to see funds participating in equity, indexes, rates, and currencies. These markets offer deep liquidity that meets the redemption requirements of investors while also providing an additional layer of diversification.
However, in some cases, this may lead to sacrificing low beta correlation for alpha. The definition of a CTA (short for Commodity Trading Advisor) is quite vague and subjective, much like its predecessor, the hedge fund.
This lack of clarity often leads to confusion and a lack of understanding among those unfamiliar with the industry. The CTA (Commodity Trading Advisor) is typically characterized by its low correlation and high liquidity.
Typically, it is possible to convert your CTA investment into cash within a period of 48 hours. As a Commodity Trading Advisor (CTA) providing a managed futures program to potential investors, it is imperative that you are registered with both the Commodity Futures Trading Commission (CFTC) and the National Futures Association (NFA).
This registration obliges you to comply with performance reporting requirements and a range of communication restrictions.
The past performance of CTAs highlights their ability to provide ample diversification to investment portfolios, with the goal of mitigating potential losses during times of prolonged market volatility in the equity markets.
Numerous academic works have been dedicated to exploring the perceived distinctions between CTAs and hedge funds. Additionally, some literature aims to separate managed futures strategies from the broader hedge fund classification.
The key takeaway from this is the significance of using correlative measures and incorporating alternative investment components such as CTAs in conventional investment portfolios.
This approach can offer diversification and the possibility of generating absolute returns even during times of unfavorable performance in equity markets.
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