Glossary of Terms: Managed Futures Basics

Economic Value of Equity

A cash flow calculation that takes the present value of all asset cash flows and subtracts the present value of all liability cash flows. This calculation is used by banks for asset/liability management. The value of a bank’s assets and liabilities are directly linked to interest rates. By calculating its EVE, a bank is able to construct models that show the effect of different interest rate changes on its total capital. This risk analysis is a key tool that allows banks to prepare against constantly changing interest rates.

Efficiency Index

This is a ratio calculated by dividing the annual return by the annualized monthly standard deviation.

Emerging Markets

Emerging Markets funds invest in securities of companies, or the sovereign debt of developing or “emerging” countries. Investments are primarily long. “Emerging Markets” include countries in Latin America, Eastern Europe, the former Soviet Union, Africa and parts of Asia. Emerging Markets – Global funds will shift their weightings among these regions according to market conditions and manager perspectives. In addition, some managers invest solely in individual regions.

Emerging Markets – Asia involves investing in the emerging markets of Asia.

Emerging Markets – Eastern Europe/CIS funds concentrate their investment activities in the nations of Eastern Europe and the CIS (the former Soviet Union).

Emerging Markets – Latin America is a strategy that entails investing throughout Central and South America.

Equity Hedge

Equity Hedge investing consists of a core holding of long equities hedged at all times with short sales of stocks and/or stock index options. Some managers maintain a substantial portion of assets within a hedged structure and commonly employ leverage. Where short sales are used, hedged assets may be comprised of an equal dollar value of long and short stock positions. Other variations use short sales unrelated to long holdings and/or puts on the S&P index and put spreads. Conservative programs mitigate market risk by maintaining market exposure from zero to 100 percent. Aggressive programs may magnify market risk by exceeding 100 percent exposure and, in some instances, maintain a short exposure. In addition to equities, some programs may have limited assets invested in other types of securities.

Equity Market Neutral

Equity Market Neutral investing seeks to profit by exploiting pricing inefficiencies between related equity securities, neutralizing exposure to market risk by combining long and short positions. Typically, the strategy is based on quantitative models for selecting specific stocks with equal dollar amounts comprising the long and short sides of the portfolio. One example of this strategy is to build portfolios made up of long positions in the strongest companies in several industries and taking corresponding short positions in those showing signs of weakness. Another variation is investing long stocks and selling short index futures.


Event–Driven is also known as “corporate life cycle” investing. This involves investing in opportunities created by significant transactional events, such as spin–offs, mergers and acquisitions, bankruptcy reorganizations, recapitalizations and share buybacks. The portfolio of some Event–Driven managers may shift in majority weighting between Risk Arbitrage and Distressed Investment instruments, while others may take a broader scope. Instruments include long and short common and preferred stocks, as well as debt securities and options. Leverage may be used by some managers. Program managers may hedge against market risk by purchasing S&P put options or put option spreads.


Fisher Effect

A theory describing the long–run relationship between inflation and interest rates. This equation tells us that, all things being equal, a rise in a country’s expected inflation rate will eventually cause an equal rise in the interest rate (and vice versa).

Fixed-Income Arbitrage

Fixed-income arbitrage is a market neutral hedging strategy that seeks to profit by exploiting pricing inefficiencies between related fixed income securities while neutralizing exposure to interest rate risk. Fixed-income arbitrage is a generic description of a variety of strategies involving investment in fixed income instruments, and weighted in an attempt to eliminate or reduce exposure to changes in the yield curve. Managers attempt to exploit relative mispricing between related sets of fixed income securities. The generic types of fixed income hedging trades include: yield–curve arbitrage, corporate versus Treasury yield spreads, municipal bond versus Treasury yield spreads and cash versus futures.

Fixed-Income: High–Yield

Fixed-income high–yield managers invest in non–investment grade debt. Objectives may range from current income to acquisition of undervalued instruments. Emphasis is placed on assessing credit risk of the issuer. Some of the available high–yield instruments include extendible/reset securities, increasing–rate notes, pay–in–kind securities, split–coupon securities and usable bonds.

Fixed-Income: Diversified

Fixed-income diversified fund may invest in a variety of fixed income strategies. While many invest in multiple strategies, others may focus on a single strategy less followed by most fixed income hedge funds. Areas of focus include municipal bonds, corporate bonds and global fixed income securities.

Fixed-Income: Mortgage–Backed

Fixed-income mortgage backed funds invest in mortgage–backed securities. Many funds focus solely on AAA–rated bonds. Instruments include: government agency, government–sponsored enterprise, private label fixed– or adjustable–rate mortgage pass–through securities, fixed– or adjustable–rate collateralized mortgage obligations (CMO’s), real estate mortgage investment conduits (REMICs) and stripped mortgage–backed securities (SMBSs). Funds may look to capitalize on security–specific mispricings. Hedging of prepayment risk and interest rate risk is common. Leverage may be used, as well as futures, short sales and options.

Fundamental Analysis

The underlying proposition of fundamental analysis is that there is a basic intrinsic value for the aggregate stock market, various industries or individual securities and that these depend on underlying economic factors. The identification and analysis of relevant variables combined with the ability to quantify the future value of these variables are key to achieving superior investment results. A wide range of financial information is evaluated in fundamental analysis, including such income statement data as sales, operating costs, pre–tax profit margin, net profit margin, return on equity, cash flow and earnings per share.

Fundamental analysis contrasts with technical analysis which contends that the prices for individual securities and the overall value of the market tend to move in trends that persist.


A future is a derivative instrument that involves a contract to buy or sell an asset (stock index, commodity, currency, fixed income or other security) for delivery at a future date at a specific price.

Futures Commission Merchant (FCM)

An individual or organization which solicits or accepts orders to buy or sell futures contracts or commodity options and accepts money or other assets from customers in connection with such orders. An FCM must be registered with the CFTC.

Futures Contract

A legally binding agreement to buy or sell a commodity or financial instrument at a later date. Futures contracts are standardized according to the quality, quantity and delivery time and location for each commodity. The only variable is price.

Futures Industry Association (FIA)

The national trade association in the United States of America for Futures Commission Merchants.



In finance, gearing (or leverage) is using given resources in such a way that the potential positive or negative outcome is magnified. It generally refers to using borrowed funds, or debt, so as to attempt to increase the returns to equity.


High Watermark

A requirement that an investment program must recoup any prior losses before the investment manager may take a performance (incentive) fee. In addition to performance losses, prior losses may include any combination of fees that the investment manager charges, such as management and administrative fees.

Hurdle Rate

The level of return (often the risk–free interest rate) which investment managers sometimes stipulate net new highs must exceed in order for performance fees to be charged.


Incentive Fee

Fee paid as an incentive to the general partner of a hedge fund or a Commodity Trading Advisor, the amount of which depends on his/her performance, usually relative to some benchmark index. Such a form of compensation could in fact extend to any financial professional, but tends to be most common among people directly responsible for managing funds.

Internal Rate of Return (IRR)

The rate of return that would make the present value of future cash flows plus the final market value of an investment or business opportunity equal the current market price of the investment or opportunity.

Intrinsic Value

The amount by which a call or put option is in the money, calculated by taking the difference between the strike price and the market price of the underlier.

Investment Strategy

An investor’s plan of distributing assets among various investments, taking into consideration such factors as individual goals, risk tolerance and horizon.



Kurtosis characterizes the relative peakedness or flatness of a distribution compared with the normal distribution. Positive kurtosis indicates relatively peaked distribution. Negative kurtosis indicates relatively flat distribution.



Leverage and gearing effectively mean the same thing: the process or effect of ‘gearing up’ or magnifying exposure to an investment strategy, manager or asset. Leverage can be achieved by borrowing capital or using derivatives . A leveraged investment is subject to a multiplied effect in the profit or loss resulting from a comparatively small change in price. Thus leverage offers the opportunity to achieve enhanced returns, but at the same time can result in a loss that is proportionally greater than the amount invested.


A time period during which a new investor in a hedge fund may not withdraw any capital committed to the fund.



Macro involves investing by making leveraged bets on anticipated price movements of stock markets, interest rates, forex and physical commodities. Macro managers employ a “top down” global approach, and may invest in any markets using any instruments to participate in expected market movements. These movements may result from forecasted shifts in world economies, political fortunes or global supply and demand for resources, both physical and financial. Exchange traded and over–the–counter derivatives are often used to magnify these price movements.

Managed Futures

The segment of the alternative investment industry which actively trades and manages futures instruments. The advisers that focus their asset management efforts on futures are known as CTAs (Commodity Trading Advisors). They invest on both the long and short side of the market and usually employ quantitative or technical analysis and systematic investment processes.


The amount of capital that has to be deposited as collateral in order to gain full exposure to an asset.


To debit or credit on a daily basis a margin account based on the close of that day’s trading session. In this way, buyers and sellers are protected against the possibility of contract default.

Market Neutral

Denotes an approach to investment where the emphasis is on the value of securities relative to each other and the use of arbitrage techniques, rather than market direction forecasting. By emphasizing the relative value of securities and the exploitation of pricing anomalies between related securities, practitioners of market neutral approaches aim to generate profits regardless of the overall direction of broad market prices. Market neutrality is generally achieved by offsetting or hedging long and short positions or maintaining balanced exposure in the market. The term market neutral can be applied with some justification to the majority of alternative investment styles because of their ability to capitalize both on upward or downward price moves or to profit in a wide range of market environments.

Market Timing

Market timing involves allocating assets among investments by switching into investments that appear to be beginning an uptrend, and switching out of investments that appear to be starting a downtrend.

Market Arbitrage

Merger arbitrage, sometimes called risk arbitrage, involves investment in event–driven situations such as leveraged buyouts, mergers and hostile takeovers. Normally, the stock of an acquisition target appreciates while the acquiring company’s stock decreases in value. These strategies generate returns by purchasing the stock of the company being acquired, and in some instances, selling short the stock of the acquiring company.

Managers may employ the use of equity options as a low–risk alternative to the outright purchase or sale of common stock. Most merger arbitrage funds hedge against market risk by purchasing S&P put options or put option spreads.


The speed of price change over a period of time. Momentum based investment styles, notably trend following approaches, aim to capitalize on the acceleration in directional price movements, be they upward or downward.

Monte Carlo Simulation

A mathematical technique used to model the price characteristics of an investment structure based on random simulations of the underlying assets or variables that affect the price of that investment. This form of analysis involves constructing multiple NAV paths for a product, net of all appropriate fees and interest, using random samples of gross monthly returns. The price characteristics that can be modeled using this powerful technique are known as ‘path–dependent’ characteristics, such as risk, return and drawdowns, which depend on NAV movements over the life of an investment structure.


National Futures Association (NFA)

Authorized by Congress in 1974 and designated by the CFTC in 1982 as a “registered futures association,” NFA is the industry wide self–regulatory organization of the futures industry.

National Introducing Brokers Association (NIBA)

A non–profit organization for guaranteed and independent introducing brokers.

Negative Gearing

Negative gearing is a form of financial leverage where an investor borrows money to buy an asset, but the income generated by that asset does not cover the interest on the loan. When the income does cover the interest it is called positive gearing. A negative gearing strategy can only make a profit if the asset rises in value by enough to cover the shortfall between the income and interest which the investor suffers. The investor must also be able to fund that shortfall until the asset is sold.

Net New Highs

A net new high is reached when the net asset value of an investment exceeds the previous peak level in the net asset value (also known as the ‘high watermark’). Performance fees are levied on net new highs.

Net Asset Value

The value of each unit of participation in a commodity pool. Basically, a calculation of assets minus liabilities plus or minus the value of open positions when marked to the market, divided by the total number of outstanding units.

Notional Funding

Notional funding is the term used for funding an account below its nominal value. For example, assume a CTA requires a minimum investment of $1,000,000 (the “Nominal Value”) and the margin requirement is $50,000.

The investor can either deposit $1,000,000 to “fully fund” that minimum investment requirement or they can invest only a portion of the $1,000,000, as long as they meet the $50,000 margin requirement. Now assume that the investor decides to fund the $1,000,000 account with $100,000 (the “Funding Level”). This means that the investor is using leverage of 10X—ten times $100,000 equals the $1,000,000 minimum investment. The difference between the nominal value ($1,000,000) and the funding level ($100,000) is $900,000. The $900,000 is referred to as “notional funding”.



These are total probability weighted gains / losses. The steeper the curve is, the less the possibility of extreme returns (risky distribution is flatter). The function is equivalent to the return distribution itself, as it combines effect of all of its moments. Returns are distributed into loss and gain above and below a return threshold and then the probability weighted ratio of returns above and below a threshold is considered.


A derivative instrument that gives the holder the right, but without any obligation, to buy (call) or sell (put) a security or asset at a fixed price within a specified period or at a particular future date.


Performance Fee

Often referred to as an incentive fee, this is the fee earned by a manager on profits that surpass the previous high watermark – the peak level in the net asset value of an investment since inception. The calculation of performance fees is sometimes based on that portion of the new highs which exceeds a hurdle rate such as the risk–free interest rate.


A representation of a track record that is developed to show the effect on actual performance of intended or potential adjustments for different fee structures, portfolio allocations or other variations in the investment structure upon which the original track record is based. It is important to note that a proforma is based on actual trading results and differs from a simulation, which models the hypothetical performance of a portfolio or investment approach that has yet to be applied or implemented in actual trading.


Qualitative Analysis

Analysis that uses subjective judgment to evaluate investments based on non–financial information such as management expertise, cyclicality of industry, strength of research and development, labor relations and depth of operational infrastructure. Qualitative analysis evaluates important factors that cannot be precisely measured, rather than the actual financial data about a company.

Quantitative Analysis

Quantitative analysis uses statistical techniques to develop investment models using key financial ratios and economic indicators. The use of objective data facilitates the comparison of a large universe of investment products to identify a select range of potential investment possibilities. Quantitative analysis deals with measurable factors in contrast from qualitative considerations, such as the character of management.



The time period in which an investor in a hedge fund or a mutual fund may withdraw his or her capital from the fund. For example, quarterly redemption allows an investor to withdraw capital every quarter.

Relative Value Arbitrage

Relative value arbitrage attempts to take advantage of relative pricing discrepancies between instruments, including equities, debt, options and futures. Managers may use mathematical, fundamental or technical analysis to determine misvaluations. Securities may be mispriced relative to the underlying security, related securities, groups of securities or the overall market. Many funds use leverage and seek opportunities globally. Arbitrage strategies include dividend arbitrage, pairs trading, options arbitrage and yield curve trading.

Risk–Adjusted Performance

Risk relative to return – the return achieved per unit of risk or the risk associated with a particular level of reward, typically represented by the Sharpe ratio. Improving the risk–adjusted return depends either on increasing returns and maintaining the level of risk, or maintaining the level of returns and lowering the associated risk.


Segregated Account

A special account used to hold and separate customers’ assets from those of the broker or firm.

Self–Regulatory Organization (SRO)

Self–regulatory organizations (i.e., the futures exchanges and National Futures Association) enforce minimum financial and sales practice requirements for their members.

Sharpe Ratio

A measure of risk–adjusted performance that indicates the level of excess return per unit of risk. In the calculation of Sharpe ratio, excess return is the return over and above the short–term risk free rate of return and this figure is divided by the risk, which is represented by the annualized volatility or standard deviation. In summary, the Sharpe Ratio is equal to compound annual rate of return minus rate of return on a risk–free investment divided by the annualized monthly standard deviation. The greater the Sharpe ratio, the greater the risk–adjusted return.


The difference between the sample or target price for buying or selling an asset and the actual price at which the transaction takes place.

Sortino Ratio

A measure of risk–adjusted performance that indicates the level of excess return per unit of downside risk. It differs from the Sharpe ratio in that it recognizes investors’ preference for upside (‘good’) over downside (‘bad’) volatility and uses a measure of ‘bad’ volatility as provided by semi–deviation – the annualized standard deviation of the returns that fall below a target return, say the risk free rate.

Standard Deviation

A widely used measurement of risk usually used to represent volatility derived by calculating the square root of the variance of the returns of an investment from their mean.

Sterling Ratio

This ratio is also a comparison of historical reward and risk and was developed by Deane Sterling Jones. The Sterling ratio is equal to the average annual rate of return for the past three calendar years divided by the average of the maximum annual drawdown in each of those three years plus 10%.


The particular investment process employed by a manager in the application of an investment style.

Stress Testing

Stress testing is a method of determining how the program will behave during a period of financial crisis. We use the worst monthly S&P 500 returns as a stress time. You can also use hypothetical scenarios (for example Monte Carlo simulation) or known historical events (for example Russian debt default in 1998 or 9/11 terrorist attacks).

Structured Product

Typically provides principal protection, invests across a range of styles and managers, provides increased investment exposure and requires a high level of structuring expertise with respect to blending investment approaches, financing, liquidity and risk management.


Technical Analysis

The basic premise of technical analysis is that prices move in trends that persist and this characteristic can be used to achieve superior returns. Technical analysis often uses computer programs to examine market data such as prices and volume of trading to make an estimate of future price trends and an investment decision.

Unlike fundamental analysis, technical analysis is not concerned with the financial position of a company.

Total Return

The total percentage return of an investment over a specified period, calculated by expressing the difference between the investment’s initial price and final price as a percentage of the initial price.

Track Record

The actual performance of an investment since inception, usually represented by audited monthly returns, net of fees.


The general direction of the market, a relatively persistent upward or downward price movement over a period, sometimes represented by the mean of price changes in that period.



A generic term used to describe the ‘instrument’ (share, bond, unit) which is issued by a product. Investors subscribe to or invest in a product by buying units and redeem their holding by selling units at the prevailing net asset value per unit, as detailed in the relevant product prospectus.


Value-Added Monthly Index (VAMI)

VAMI is defined as the growth in value of an average $1,000 investment. VAMI is calculated by multiplying (1 + current monthly ROR) X (previous monthly VAMI). VAMI assumes the reinvestment of all profits and interest income. Incentive and management fees have been deducted.

Value–At–Risk (VAR)

A widely used risk measurement technique that calculates (at a pre–specified level of probability) the loss that would be experienced in a day or some other pre–specified time horizon in the event of an increase in volatility or an adverse correlated move in market prices, assets or the investments making up a portfolio.


Volatility is the measurement of risk used most often in the investment industry. Put simply, it measures how variable price changes are in relation to the price trend for an investment. It is important to note that volatility says nothing about the direction of the trend itself. Expressed in slightly more technical terms, volatility is a measure of how much a set of returns for an investment deviates from the price trend or mean of that investment. It is usually calculated as ‘standard deviation’ and expressed as ‘annualized volatility’ – the standard deviation on a yearly basis.



The relative proportion of each of a group of securities or asset classes within a single investment portfolio.



The amount of interest or dividend paid on a loan or an investment, expressed as a percentage. The yield on a stock is calculated by dividing the dividend by the current market price.