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 fund is not fully appreciated in the context of diversified portfolio construction and alternative investments.
Despite being a common term in the financial industry, Commodity Trading Advisor (CTA) is also often misunderstood, even by professionals in the field.
It is important to define the terms “CTA” and “Hedge Fund” before discussing their relationship.
If you want to invest as an expat or high-net-worth individual, which is what I specialize in, you can email me ([email protected]) or use WhatsApp (+44-7393-450-837). This content isn’t financial, legal, tax or any other kind of individual advice, nor a solicitation to invest.
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 a hedge fund to continuously minimize the potential for losses.
It is a common misconception that a hedge fund is inherently aggressive or risky. 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.
However, 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 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.
What is a Commodity Trading Advisor?
A commodity 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 comply with CFTC laws and NFA standards, the Commission formed the Association in 1981.
A 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 Commodities Futures Exam. If advisers can demonstrate that they meet certain requirements, they won’t have to be registered.
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 CTA with the NFA, with a few limited exceptions.
Individuals who register as a CTA solely with the 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 CTA can only be done through the (CFTC) and not through the NFA.
Passing The National Commodities Futures Exam
Typically, individuals seeking to become a CTA must first pass the National Commodities Futures Exam, also known as the Series 3 exam, which is regulated by the Financial Industry Regulatory Authority (FINRA).
The 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 CTA with the 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 of 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 CTA, it is a requirement to hold membership with the 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 CTA, the initial step is to appoint a security manager who will facilitate secure access to the NFA’s 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 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 CTA from the 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 CTA;
- A CFTC-registered entity provides advice that is incidental to their primary business or profession; or
- The guidance given lacks knowledge of or tailored consideration for a customer’s trading 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 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 require a minimum investment of $10,000. To clarify, calls-to-action have the potential to generate a substantial amount of revenue.
It is advisable for clients to verify the registration of their chosen CTA with both the CFTC and the 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, they 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 specialize in providing guidance on commodities and futures trading to their clients. They also help their clients achieve their financial objectives.
CTA vs Hedge Fund: The Differences
A CTA is an individual or 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.
Unlike a CTA, a hedge fund manager does not necessarily focus on commodities or other derivatives. Hedge funds can invest in commodities or derivatives, but also in stocks, bonds, and other various types of product.
A CTA must be registered with the NFA and subject to regulation by the CFTC to work as a CTA with clients, which means that CTAs should be mindful of certain up-to-date compliance requirements.
A hedge fund is not exempt from all regulations. It also has to be compliant with its regulatory body such as SEC. However, compared to a CTA, hedge fund can be under less strict regulatory regime, as it depends on, for example, what kinds of investment products and strategies it employs.
Depending on the contexts, CTA and hedge fund may be used interchangeably, though.
Pained by financial indecision?
Adam is an internationally recognised author on financial matters with over 830million answer views on Quora, a widely sold book on Amazon, and a contributor on Forbes.
