Investors in the $337 billion managed-futures market, expecting returns that will defy stock market slumps, instead find most of their gains gobbled up by commissions.
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.
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.
David Fuller's view This is a long article but it is certainly worth reading because the charges are outrageous, including incentive fees for brokers of up to 4 percent of assets invested and investors paying up to 9 percent in total first year fees.
Throughout my long career to date the most newsworthy financial scandals have been about scams, from Charles Ponzi to Berne Madoff. However, I recall far more complaints from investors over fund management fees. These latter problems occurred because a few exceptional managers were treated like rock stars, tempting them to raise fees. That opened the door for less successful managers to increase their charges, even though some are no more than closet index trackers. Others roll the dice and get lucky thanks to leverage, and are then tempted to increase management fees.
The best protection for investors is due diligence. When considering funds, find our what fees are being charged. Also, find out what leverage may be used, especially with hedge funds. I am not against leverage per se and use if myself when trading. However, leverage is a double-edged sword and its use inevitably increases speculative risks.