Managed Accounts - Road to Wealth or Ruin?
A managed account is where you have an account with a broker (a stock trading account, a futures trading account or a forex account) and you let someone else trade your account. In addition to the brokerage, they also extract a performance fee. This is called discretionary trading. Another term for this is a CTA managed account.
In theory, you have a professional placing the trades and managing your money, they are trading tested systems, so you can just sit back and watch the dollars roll in. Is it this good in practice, and what do you need to know before signing up?
Not surprisingly, the answer is “it varies”. Some CTAs are excellent, some are totally dire. In my own experience, generally discretionary trading on an account is not a good thing. This is because it generally doesn’t make any money. There are more fun ways of using money than giving it to brokers!
In any enterprise, especially in the markets, most people will barely survive, and a few people will be very successful. If you want someone to manage YOUR money, you need to identify the latter types.
The value proposition is clear for a broker who trades your account. They get commissions, plus a performance fee. If they lose, there is no downside risk. If they win, then they get a performance fee. This is not bad in itself, but the link between trading activity and commissions is of concern. This means that the more trades that are placed, the higher the brokerage.
My own view of brokers managing your account is influenced by my observations of a local futures broker that I had an account with (I did not allow discretionary trading on my account). They developed a trading system based on neural networks that was heavily curve fitted, and solicited accounts. The clients ended up losing most of their money when the theoretical returns (not surprisingly) did not eventuate. They also had a tip sheet that had similar results.
The issue in this case was that the motivation was to extract as much brokerage as possible from each client, since on average most clients lost. The broker had little idea of the market, and employed order takers rather than professional traders. One other thing that they did was coat-tail successful traders. No-one was successful in trading on their own accounts, yet they wanted to manage the money of other people.
So how can you distinguish between the winners and the losers? A good one will be able to show a real performance history rather than just a theoretical return. If you compare the two, actual trading performance will always show a far higher monthly standard deviation (a measure of the variability of returns) than a hypothetical performance projection. The drawdown will be higher and the returns will be lower.
You can find rankings of CTAs at Attain Capital. You can also look at trading systems that are offered (which is a similar thing) and see how they have performed in real life trading at Collective2.
A good CTA will be focussed on earning most of their income from performance fees rather than brokerage. They will have their own money in the fund rather than just using other people’s money. They will be able to demonstrate a history of full time trading in the markets, preferably with a large organisation such as an investment bank. Investment banks tend to not select or retain traders who lose their money.
Make sure that they are properly authorised to trade on your account - in the US if someone trades on your account, they must be a registered CTA. Just because they are registered doesn’t make them a trading guru. In other jurisdictions, a broker can trade your account if you authorise them to do so.
In conclusion, don’t write off managed accounts, but chose the traders who can help you, not those who have an eye on how much brokerage they can rip off and who can’t demonstrate a performance history.
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