Feb 28, 2020 By: Matt Anderson Turnkey Trading Partners is one of the industry’s largest providers of Commodity Trading Advisor (“CTA”) accounting and performance calculation services. While processing return information, Turnkey’s accounting department often finds differences in rates of return (“ROR”) across client accounts within the same trading strategy. While variance in trading performance has always been a concern for CTAs, it has become a “hot topic” during National Futures Association (“NFA”) audits so far for 2020. NFA recently rolled out new guidance regarding performance disclosures during August of 2019 which are now being scrutinized during field reviews. “Acceptable” Variance It is important to remember that not all ROR variance within a performance composite is necessarily problematic. For example, varying transactional and advisory fee structures, or interest income payments between clients, may legitimately impact ROR on an account by account basis. Generally, under such circumstances, NFA will take these differences into consideration during performance testing. The real concern when evaluating variance is whether or not accounts with a similar underlying account structure, within the same performance presentation, show “materially” different rates of return for unacceptable reasons. What does NFA consider to be “Material” According to NFA material differences would be identified if: The composite ROR including the account and the composite ROR excluding the account average 10% or more, they are materially the same if the difference between the two RORs is less than 10% of their average. The composite ROR including the account and the composite ROR excluding the account average less than 10% and greater than 5%, they are materially the same if the absolute difference between the two RORs is no more than 1.5%. The composite ROR including the account and the composite ROR excluding the account average 5% or less, they are materially the same if the absolute difference between the two RORs is no more than 1%. NFA’s definitions make materiality easier to identify, but they do not present the entire picture. These guidelines should only be used as a tool to spot potential allocation or performance problems. For example, accounts within the same composite or strategy can have similar returns even if they were not being traded the same. In other words, customers within the same composite should have taken the same pro-rata trades, rather than simply ending a reporting period with similar results. During performance testing, NFA will almost always evaluate this. As a regulator, NFA also has a mandate to ensure that a CTA’s allocation process is repeatable over time while also being just, fair, and equitable to all accounts within a blocked order. Causes Of Return Variance Over the years Turnkey has seen a wide and diverse range of reasons as to why CTA performance variance might occur. If and when a CTA experiences rate of return variance, it is important to first isolate where the problem(s) originated from. Items of concern might be, but are not necessarily limited to, human error (whether unintentional or intentional), technological problems, leverage or notional funding issues, and process or communication issues with a customer’s FCM. Regardless of the reason, variance and materiality concerns within a composite cannot be addressed properly until the root cause of the problem is discovered. While some allocation concerns may be simple to correct, often identifying allocation and performance presentation errors may require the assistance of a third-party provider. Similarly, correcting any identified allocation problems, either through trade process changes or policy implementation might be best left to someone with years of experience. Either way, when there is rate of return variance within a CFTC composite performance presentation it should be addressed as soon as possible. How To Avoid Allocation and Performance Reporting Errors Understand NFA rules and regulations on the subject, specifically 9054 – COMPLIANCE RULE 2-34: CTA PERFORMANCE REPORTING AND DISCLOSURES. Work with a third party that has experience in compiling CFTC and NFA compliant CTA performance figures. Review trade statements for proper position allocations on a daily basis. Also ensure trade allocation and block order allocation procedures are evaluated and reviewed at least quarterly. Review monthly performance accounting reports in detail to ensure that consistent performance accounting is occurring across all customer accounts. This is the first line of defense in spotting and alleviating a variance problem before it gets worse over time. Also ensure at least once per month (if not more frequently) that instructions on file with an introducing broker (“IB”) or Futures Commission Merchant (“FCM”) for executing and allocating orders remain accurate. Consider hiring a qualified third-party organization to conduct a mock audit of your CTA. This review should consider compliance, allocation processes, and performance reporting. Many established firms will have a qualified third-party provider conduct a complete “mock audit” every 12 to 18 months. If any errors or deficiencies are identified, ensure they are well documented and information about corrective action is kept on file. This information should be kept readily available to reference during an NFA Audit. Correcting Allocation or Variance Concerns NFA has updated its guidance on the allowable variation in ROR across accounts within the same trading program. They are also more actively testing CTA performance variance during their examinations. CTA’s with potential concerns should address any allocation or performance variation matters as soon as possible. Turnkey Trading Partners can help with both performance accounting and providing mock audit services to your firm. To learn more about Turnkey’s mock audit and/or performance accounting services please contact us today via – email@example.com or (312) 324-0040. If you’re not a subscriber to our newsletter? You’re missing out! Sign up and request to receive more information here. About the Author Matt joined Turnkey after completing his M.S. in Financial Economics from Florida Atlantic University. While pursuing his Master’s, Matt managed a small team for a financial technology startup, where he focused on evaluating trader returns and strategies. Matt will serve in a hybrid role at Turnkey, where he will assist with our performance accounting efforts, client experience, and day-to-day operations. He holds his Bachelor’s in Business Administration from Oglethorpe University in Atlanta.