Jan 29, 2021 Many traders who have experienced some success managing their own money have asked themselves the question: “Should I do this professionally?” The answer to this question is certainly nuanced and one that requires a great deal of consideration. As one of the leading derivatives consulting firms in the United States, Turnkey Trading Partners (“Turnkey”) has years of experience helping traders with this question. Roughly ten years ago Turnkey wrote a comprehensive article on this subject. With the dawn of a new year and the start of a new decade, our staff felt it would be a good idea to revisit this popular question for people. What follows is a revision of our original article which has been modified to consider any material changes which have occurred in the last ten years. Commodity Trading Advisor or Commodity Pool Operator Turnkey is routinely asked about the advantages and disadvantages of starting a CTA or a CPO. This is a great question and one that all money managers interested in trading derivatives should consider. After years of experience Turnkey has seen the damage that can come if this question is answered incorrectly. Quite literally the wrong structure could ruin the chances for success as a CFTC registrant and NFA member. At the very least an incorrect decision at formation could waste thousands of dollars and countless hours of valuable time. Initial Considerations There are many considerations that must be accounted for when determining how to begin any trading operation. Some of these considerations are relatively simple to evaluate, others complex. The following is a list of questions all traders MUST ask themselves as they evaluate their options. How strong is my track record relative to my peers? How strong is my background relative to my peers? How will I raise assets? Do I have access to capital? What products will I trade and focus on? How large an investment will be required from each customer? And many others… What is our competitive advantage? A large majority of the people Turnkey speaks with have aspirations to start the next big “Hedge Fund” but they have no idea what this means. While this aspiration may turn out to be true, it’s not likely if the members of a company have no prior experience in the financial markets. Entering into any highly regulated, highly competitive industry exposes people to an incredibly steep learning curve. As with any best-in-class operation it probably won’t be realistic to assume that the “next big fund” will be run by a group of individuals with no prior experience managing client money. Certainly, anything is possible, its simply highly unlikely. In making a decision to start a CPO or a CTA, that is whether or not to pursue a fund or separately managed account structure, it’s very important to assess the company’s skill sets against industry peers. In this area the two biggest questions to answer should be “Does our track record reflect strong, consistent results which are sector competitive?” and “Do we have the experience and background to be trusted with people’s assets?” How will the company gain access to investment capital? Once it has been determined if realistic competitive advantages exist, then an honest assessment of who might invest should be the next focus. Consider how many investors (realistically) the company likely will have access to? Is it 1, 5, 20, 1,000 or more? Of these people how many of them are likely to invest within the program? How many of them will be institutional or high net worth investors? What will the average deposit size likely be? After these points have been considered, then it should be relatively easy to determine how much capital may be available to the strategy at its inception. A strategy with no access to capital is dead on arrival. This exercise will also help to more readily identify the path that should be pursued – CTA or CPO. While considering this remember that 1,000 accounts depositing $10,000 each is not equivalent to one account investing $10 million independently. There are wildly different administrative costs and operational requirements to manage 1,000 accounts relative to managing only one. How large an investment is required to trade the strategy? Assuming a competitive advantage exists. Assuming a realistic pathway to investment capital exists. The next consideration should be determining the minimum investment required to participate in the trading program. Will clients be able to access the model with a $10,000, $50,000, $250,000, $5 Million Dollar or more deposit? What is the capacity of the trading strategy based on market liquidity and trading approach? It will be important to determine the minimum amount of funds needed under management to effectively trade the program. Here are a few basic things that should be immediately considered in this area: How large will anticipated drawdowns be? Can client accounts survive a hypothetical “worst- case” scenario with the funding level selected? Based on the products being traded will the accounts have enough funds to cover initial margin? Will they have the resources to invest across several markets or product types simultaneously? How much leverage does the program require? What will account margin to equity be under normal trading conditions? Under extreme trading conditions? Will notional funding be used or considered –what implications will this have on program volatility? Is notional funding under CFTC and NFA regulation even understood by the company and its traders? How much in assets under management will the company require to remain viable? A pro-forma estimation of profitability should be performed and taken into consideration. Turnkey provides a free basic tool to calculate this which can be requested here. Advantages and Disadvantages After the above questions have been considered they should be evaluated in their totality. In other words, each set of answers from above will offer different insight into the fund or managed account structural decision. For many, at this time, it will be in the company’s best interest to contact a regulatory professional like Turnkey Trading Partners to discuss the “pros and cons” between separately managed accounts and a fund structure. Firms like Turnkey should be willing to provide a free evaluation of each trader’s unique circumstances. Below we have provided some basic advantages and disadvantages to each structure which should be considered: Commodity Trading Advisor (Separately Managed Accounts) Individually managed client accounts have the following advantages: Administration, start-up, and maintenance costs are very low Regulatory requirements and overall learning curve relatively low In general, overall costs to the investor should be less Accounting and financial requirements are significantly less complex Client funds must be held with a clearing firm rather than a private fund; reduced fraud risk Individually managed client accounts have the following disadvantages: May require a higher minimum investment as assets will not be pooled Challenging if not impossible to diversify into multiple strategies or investment opportunities Client accounts will have to adhere to strict individual margin requirements Eventually can become a challenge to scale as the number of investors grows CTA clients will be known to other brokers and trading information will not remain anonymous Commodity Pool Operator (“Hedge Fund”) Pooling client assets as a registered fund has the following advantages: Can allow for greater strategy diversification and investment opportunity Minimum investment levels may be lower as accounts are pooled May provide investors with a more focused investment advisor Individual investors will not be responsible for margin obligations May allow for the operator to reduce expenses and charge additional fees; profit margins can be higher Pooling client assets as a registered fund has the following disadvantages: Administration, start-up, and maintenance costs are high Regulatory requirements and learning curve significantly steeper SEC/FINRA/CFTC/NFA/State Security regulation may be required In a post “Madoff” world, investors may be wary of depositing funds with new managers Hurdles for clients to profit and/or break even within the strategy are relatively high May require a funding threshold to be hit in order to begin trading Generally, requires a longer track record to gain investor attention Costs Estimates The last consideration in forming a trading business is based on cost and budget. After forming hundreds of CTAs and CPOs Turnkey has a great deal of insight into this market place. On this basis we have put together general pricing estimates, in 2021 dollars. CTA Costs (Separately Managed Accounts) CTA Pricing Assumptions: A United States based, Commodity Trading Advisor, trading only commodity interest products. This is the most common structure for a CFTC/NFA regulated commodity trading advisor. Any other structures and or considerations may materially impact pricing. The price ranges reflected below represent actual costs we’ve seen advertised or paid within the industry over the past few years. Final pricing will be driven by each traders unique circumstances. Pricing presented is not necessarily indicative of Turnkey’s pricing. Turnkey is among the most competent and competitively priced providers within the consulting industry. A dialog with a Turnkey Trading Partners staff member will be required to discuss each traders’ individual circumstances. Average Formation Costs – $250+ company formation* – $750 Annual NFA dues (depending on instruments to be traded) – $200 NFA application fee (one time) – $85 NFA registration; $15 fingerprints if needed (per person) – $3,500+ for Disclosure Document or Disclosure Memorandum plus required client forms* – $3,500+ for Mandatory compliance manual* Average Annual Ongoing Costs – $165 to $1,000+ Monthly performance accounting* – $100 per person ongoing training (Cybersecurity/Ethics) – $195 to $1,000+ per month compliance and legal* Optional Costs – $1,500 to $10,000+ Marketing Materials* *Additional discussion required; costs variable by project; some costs may not be applicable in all cases. CPO Costs (“Hedge Fund”) CPO Pricing Assumptions: A United States based, Regulation D, Private Placement Fund, trading in only commodity interest products. This is the most common structure for CFTC/NFA regulated commodity interest pools. Any other structures and or considerations may materially impact pricing. The price ranges reflected below represent actual costs we’ve seen advertised or paid within the industry over the past few years. Pricing presented is not necessarily indicative of Turnkey’s pricing. Turnkey is among the most competent and competitively priced providers within the consulting industry. A dialog with a Turnkey Trading Partners staff member will be required to discuss each traders’ individual circumstances. Average Formation Costs – $300 to $3,000 management company formation* – $300 to $3,000 fund company formation* – $750 Annual NFA dues – $200 NFA application fee (one time) – $85 NFA registration; $15 fingerprints if needed (per person) – $10,000 to $50,000+ for fund PPM* – $2,500 to $10,000 for mandatory compliance manual* – $200 to $500 per US State for “Blue Sky” filings* Average Annual Ongoing Costs – $5,000 to $30,000+ Required annual certified audit* – $500 to thousands + Monthly fund accounting* – $1,000+ tax reporting* – $100 per person ongoing training (AML/Cybersecurity/Ethics) – $250 to $1,000+ per month compliance and legal* Optional Costs – $1,500 to $10,000+ Marketing Materials* *Additional discussion required; costs variable by project; some costs may not be applicable in all cases. Conclusion Making the decision to begin managing client funds is a difficult one. With proper preparation the decision to move forward can be incredibly rewarding. Since our inception Turnkey has assisted hundreds of traders in evaluating their options. It would be our privilege to assist in developing your trading business. Although the financial markets can be uncertain, one thing is for sure, those who fail to plan as the enter this industry will likely never get off the ground. Please contact a Turnkey Trading Partners representative today with any questions you may have. We can be reached via phone by calling (312) 324-0040. If you’d prefer to contact us by email you may reach us using the address firstname.lastname@example.org.