Why to be wary of managed futures funds

(MoneyWatch) A recent Bloomberg news article on a managed futures fund managed by Morgan Stanley caught the attention of my colleague Kevin Grogan. The article describes how several managed futures funds offered through a limited partnership structure charged fees that were so high that they wiped out any gain for the investor.

Managed futures are alternative investments that performed well in 2008, when equities and most other alternative strategies did poorly. Unfortunately, this good past performance made investors ripe for pitches for complicated, opaque, high-fee managed futures funds. Here is a summary of the highlights (or lowlights) of these strategies cited in the article:

• The Morgan Stanley Smith Barney Spectrum Technical LP fund made $490 million in trading gains and income from 2003 to 2012. However, these profits did not accrue to the investors who bore all the risks. Instead, Morgan Stanley and the fund managers made $499 million in commissions, expenses and fees.
• According to the SEC, 89 percent of the $11.5 billion of gains in 63 managed futures funds went to fees, commissions and expenses from 2003 to 2012.
• Brokers who sell these products have an incentive to keep clients in managed futures funds because they receive commissions annually of up to 4 percent of assets invested. Investors pay as much as 9 percent in total fees each year.
• The prospectus of some of these funds allow their managers to make "side bets" by trading ahead or opposite the fund's trades -- a clear conflict of interest, and a red flag if ever there was one.
• Ken Steben, the manager of a managed futures fund marketed by Wells Fargo and Ameriprise, made a shocking admission: "Most individual investors don't understand what we're doing. In many cases, the financial advisers don't completely understand it."

• Fees matter: Clearly, managed futures strategies delivered on their "promise" -- gross of fees. Unfortunately, the only returns investors can spend are net of fees and expenses (including taxes).
• Beware of conflicts of interest: The brokers who sold these strategies were heavily incented to do so. Also, the fact that fund managers are allowed to front-run or trade opposite their own fund's trades is a huge red flag.
• Warren Buffet once advised to "never invest in a business you can't understand." This advice could be extended to all types of investing. If you don't understand the investment, it is best to stay away.