Is Managed Futures Secret Weapon Coming Back?

A long time ago, in a galaxy not so far away – where China was preparing for the Summer Olympics, Kosovo declared independence from Serbia, and Crude Oil was hitting levels at $140; a small band of rebels called short term interest rates were actually whole numbers (like 1%, 2%, and 3%).  That may sound like science fiction to some, but it was real. People could purchase a 1 year T-Bill for say, $97,000, and have $100,000 returned to them 12 months later; compared with the ability to purchase a 1 year T-Bill in 2014 for say, $99,875 ; and get back that $100,000 12 months later.

Fast forward to today – and something exciting is happening in short term rates. We’re not talking science fiction exciting just yet, but there’s significant movement for the first time in years… in short term rates as the world prepares for Ms. Yellen to finally announce an increase in interest rates. Via Zerohedge, we see that the One Year T-Bill has reached rates it hasn’t seen since 2010:

“The US Treasury sold $25 billion of one-year T-bills at an interest rate of 33bps yesterday, the highest since June 2010. It appears the short-end of the yield curve is increasingly pricing in ‘liftoff’ sooner rather than later (and the long-end is responding by rallying – lower in yield – as medium term growth expectations fade) but it raises significant questions about the economic trajectory after the hike (and the ebbing confidence in The Fed).”

(Disclaimer: Past performance is not necessarily indicative of future results)
Chart Courtesy: Zerohedge

Now, trying to 1/3^rd of one percent in interest surely isn’t the type of return anyone outside of the money market or commercial paper industry is likely to get excited about. But what if instead of the option of earning 1/3 of 1% (33 basis points as they say in the biz) OR 7.5% on xyz investment, the choice was to earn 1/3 of 1%  AND the 7.5%. AND is certainly more enticing than OR in that scenario.

Managed futures secret weapon, so to speak; is its ability to harness the power of US Treasury Bills at the same time it is putting trades on with commodity futures. In short, the secret weapon is the ability to earn both interest and trading returns on the same money.

What? How can you have two investments at once?  You can’t buy a house for $500,000 and earn interest on that $500K for example; nor can you purchase $100,000 worth of stock, and at the same time earn interest on that $100K.  Turns out managed futures playground of exchange traded futures allows for investors to invest cash into a futures account to invest in a managed futures program, and at the same time earn interest on the majority of that cash.  This works because the futures exchanges and FCMs clearing the trades there allow for T-Bills to be used to cover margin requirements. Bear in mind, futures account margin is not the same thing as stock account margin. Futures account margin is essentially just needing to have a certain amount of money in an account for them to allow you to enter into trades, versus stock account margin where you borrow money to purchase shares.

At the end of the day, the exchanges and FCMs want you to have collateral to act as a buffer against any moves against your positions in the future. So they can take money from those who lose money on a trade to pay those who made money on it. That’s what the exchanges do. The good news – they view T-Bills and cash essentially the same. So you don’t need to have $100,000 in cash to act as collateral; and another $100,000 to put into T-Bills. You can use the same $100,000 to both buy T-Bills and cover margin for your investment in a futures program. That’s right, the T-Bill does double duty – with the clearing firm posting the T-Bill to the exchange on your behalf to cover margin and you earning the interest on it while it sits with the exchange.

Now, the clearing firms do build in a little buffer for themselves as a risk precaution, and usually only allow around 90% of the T-Bill’s face value to be used as margin, and those fees and haircuts made it a breakeven (to losing) proposition when 1 year interest rates were at 0.10%. But with the potential gain 3 times that now… it’s starting to make sense again. And should we get back to the 1% to 3% environment, it’s a must have for any serious investors. Who doesn’t want an extra 100 to 300 basis points per year tailwind.

PS – For those investors having their accounts professionally managed. You don’t want to purchase a T-Bill in the account the advisor in managing. The interest earned will increase the value of that account, and you don’t need to be paying the advisor 20% of the profits due to interest, just pay him or her on the profits due to their trading.

PPS – The exchanges also allow certain stocks to be used as collateral. So if you loath to sell that Apple stock, but like the managed futures value proposition – there’s ways to use your stock as collateral in much the same way as T-Bills. Call us for more information on how that works (312-870-1500).