There are a few other sticky wickets, or Macro-Disqualifiers fund administrators must negotiate. For example, a fiduciary must’ act solely in the interest of participants and beneficiaries and keep expenses to the minimum. Additionally, the fiduciary is prohibited from self-dealing, acting as a party with a competing or adverse interest in the plan, and receiving any compensation from any other party other than the plan. In other words, neither the FCM nor the trading manager should be named as a fiduciary. Both of these entities are expected to cross-trade (represent both sides of a futures trade by brokering for customers who are long and others short), work on an incentive fee basis (a conflict of interest with the pension fund), and provide a variety of services with compensation from multiple sources—all in the normal course of one business day.

Fiduciaries have two additional duties that impact managed futures: diversification and documentation. It is their responsibility to see that the fund they supervise is balanced so as to minimize the risks of loss, unless they can show it is clearly prudent not to do so. On this count, it has been demonstrated that managed futures, because of its negative correlation to traditional investments, enhances diversification.

FundsDocumentation has two meanings for fiduciaries. First, they must follow as exactly as possible the plan for the fund as it is spelled out in the fund’s documentation. Secondly, they must always be prepared to substantiate their actions.

In the first situation, the plan for the pension may need to be amended before permitting an investment in managed futures. Depending on the individuals involved and the structure of the plan, this could be a simple or an impossible task. In some cases, it is impossible and becomes a Macro-Disqualifier. At other times, all it takes is a five-minute meeting of the trustees.

The second part of the documentation can be easily dealt with, but should not be taken lightly. The usual procedure, if capabilities are not present in-house, is to hire a consulting firm specializing in asset allocation. Remember the first two commandments of ERISA be prudent and be able to prove it. The consultant needs to have access to a complete database of CTAs. The current asset allocation of the fund is inputted into the asset allocation model and an optimum efficient frontier is created. This allocation is then modified with the addition of various CTA teams, who have to be selected on the basis of the quality of their trading and their negative correlation to one another.

One of the most common questions asked by pension fund managers involves how a pension plan, whose assets are required by law to be held in trust, can have funds with an FCM that is not a fiduciary. Additionally, the FCM, by CFTC regulation, must be able to commit those funds to the market at a moment’s notice to meet a margin call. All this sounds like a major conflict between ERISA and the CFTC. The Department of Labor solved this problem in 1982. It held that assets used by an FCM for margin were not plan assets for the purposes of the fiduciary requirements of ERISA. Nevertheless, fiduciaries must promptly sweep all excess margin from futures trading accounts.

The last question we need to touch on is whether the fiduciaries of ERISA pooled investment vehicles, such as master funds, common trust funds, mutual funds, etc., are required to comply with CFTC rules governing commodity pool operators (CPOs). An exclusion is available if these pools are not available to the public, use futures and options solely as a hedge, submit to special calls made by the CFTC, and certain percentages of total asset limitations are maintained.

Checklist for Pension Funds Investing in Managed Futures

This is a brief guide to the major issues that must be addressed before a pension fund invests in a managed futures program:

  • Risk vs. Reward Analysis—Step one is to do some serious analysis to determine the increase in return and the reduction in volatility that can be expected from the addition of managed futures to the current asset allocation mix.
  • Legalities—A wide array of state (insurance, security, labor, security) and federal (Dept. of Labor, SEC, CFTC, IRS) agencies are involved. The first step is to prepare an assessment of which agencies are involved and to what extent. An estimate of the cost and problems of compliance with each jurisdiction needs to be presented to the trustees.
  • Documentation—The plan and trust agreement must be reviewed to see what changes, if any, would be required. Proper authorization from the board of directors or trustees would be required.
  • Preliminary Trading Plan—This would detail the trading objectives and limitations to be placed on the commodity trading advisors, as well as a policy statement.
  • Management and Control—Specific procedures should be prepared for the records that will be kept, adjustments to accounting, the tracking system, and any special personnel, equipment, or reports required.
  • Evaluation—Thecriteria to measure the success or failure of the project should be clearly set out in writing in advance.

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