Does Interactive Brokers support Notionally Funded account?

Does Interactive Brokers support Notionally Funded account?

Or all accounts must be fully funded?

 

What exactly do you mean..notional in what way?

 

For example, if you are a CTA and I like you to trade my account-A.

I will deposit $100K cash into my account-A. But you, as a CTA, will trade it as if it was $200K account.

Assuming some one else also has an account-B. He deposits $200K cash into such account-B. You as a CTA also trade such account-B

You will trade both accounts identical (both have the account size of $200k).

Since my account-A only have $100K cash, but you will treat it as if it was notionally funded account with total nominal account size of $200K.

Does this make sense to you?

I just do not know if Interactive Brokers support this type of account either with Interactive Brokers or through give-up.

 

A very interesting and important topic indeed.

Any update?

How about the notional % for different accounts with various clients would have different % for individual accounts: say some are 30% funded, some 40%, some 50% and some 60%, besides some are fully (100%) funded.

Even worst, a client's account may be only 10% funded but the historical MaxDD has been over 15% several times.

How would a CTA (or IB) handle the above transactions/scenarios?

 

how is this different from trading on margin with account A and not on margin with account B?

 

I think this topic can be very complicate.

If all accounts are fully funded, distribution of trades can be easily calculated/done, and re-investing profits can be easily implemented/done as well.

When some accounts are partly funded with notional funds, I guess the act of re-investing profits would automatically reduce the funding %, say, probably from 30% initially reduced/down to 10% graduallly (becoming more more risky for margin calls).

Must be something wrong with my thoughts above, am I?

 

Performance on a notional account is not for IB to calculate. That is purely the job of the fund admin. With regard to IB, the only difference notional funding makes is in determining what the management fees should be, as these are charged on the nominal account value which includes notional funds.

From your standpoint as the firm's principal, you have to do a couple things.

1) Each account that will be trading notional funds needs to have a notional funding agreement, complete with full disclosures as to the risks and behaviors of notional accounts.

2) This contract must also describe in detail how management fees will be charged to the account. Usually this will be charged to the nominal value (cash + notional)

3) This contract will include the agreed upon nominal value, as well as any provision for increasing that nominal amount.

That brings us to the next point. Generally notional accounts do not scale like cash accounts. Profits are obviously reinvested, but do not increase the trading level of the account, until a new nominal value is agreed to IN WRITING.

So if an account is cash funded to $75K and you've agreed on a nominal trading value of $100K....

A 2% management fee would be $2K annual, not $1,500.

If the client realizes gains of $20K, the nominal trading level will still be $100K, not $120K.

Performance is calculated on the $100K nominal NAV. Simply take the MTM $PnL and divide it into $100K each month (net of fees obviously). That is the performance, and it is on you to track that, not IB. Once the actual cash balance passes the $100K nominal level, you can either scale it on a pure cash basis, or agree to another level of notional funding.

Re: mechanics of trading notional accounts within TWS...

You obviously can't just enter bunch orders (or block orders as they are mistakenly called) based on account NAV. You must create an account profile, and enter either allocation percentages or ratios.

And yes... obviously the risk of margin calls increases on these accounts. Hence the need for full risk disclosures.

 

Not to be a jerk here, but I should note that anyone who doesn't already know what was in my previous post, shouldn't be trading notional funds in discretionary accounts. It is something you should become familiar with, but until you completely know what you are talking about, and the regulations involved, you are taking on a lot of risk in managing notional funds.

How can your client understand it fully when you don't?

 

Thanks Epic for your comments.

Just did a google search and found:

Q
http://www.nfa.futures.org/NFA-faqs...losure-documents/what-are-notional-funds.HTML

What are notional funds?

An account is notionally funded when the client directs the CTA to trade the account as if the funding amount was higher than the actual funds on deposit in the client's account. This does not, however, mean that the account may trade undermargined. Notional funding is allowed as long as certain criteria are met, including having a written agreement in place between the firm and the client . Review NFA Compliance Rule 2-34 and the Interpretive Notice 9054 for more guidance.
UQ

http://www.nfa.futures.org/nfamanual/NFAManual.aspx?RuleID=RULE 2-34&Section=4

http://www.nfa.futures.org/nfamanual/NFAManual.aspx?RuleID=9054&Section=9

Q
http://www.pfgfunds.com/managedfutures.asp

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 she can invest only a portion of the $1,000,000, as long as she meets 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”.

Investors are interested in using notional funding because notional funding capitalizes on the free cost of leverage. The leverage is free because the notionally funded amount (in this case, the $900,000) is not borrowed or deposited—the Funding Level ($100,000) is a good faith deposit for the full value of the account. In other words, the $100,000 trades as if it were $1,000,000, even though the investor only deposited $100,000 and is not paying interest or has not otherwise borrowed the remaining $900,000. If the account is doing well, the investor earns money on the full $1,000,000—even though she only funded the account with $100,000. If the account is not doing well, however, the investor is responsible for the amount lost, regardless as to the original Funding Level, up to the Nominal Value.

For example, assume that the account has a profitable year and the CTA reports profits of 20% ($200,000) for the fully funded account. The account that was only funded with $100,000 also had $200,000 in gains—but the investor’s profit percentage was 200%, because the investor earned $200,000 on a $100,000 investment. Investors must be aware, however, that this is a double edged sword. If the account has a drawdown, the investor will suffer a significantly larger percentage decline than the fully funded account. If the example above suffered a 20% drawdown for the fully funded account, the notionally funded account would have a 200% drawdown. In such a situation, the investor would not only have lost her initial $100,000 investment, but also an additional $100,000. Furthermore, to keep the account open, the investor would have to deposit at least enough cash to cover the margin requirement.

In this regard, notional funding significantly increases the volatility of an account. Investors must ensure that they understand how much leverage the CTA is using—and the consequences such leverage might entail.

UQ

 

Q
http://www.sfomag.com/Commentary/Vi..._Minimums_Through_Notional_Funding-fe185.aspx

Invest at Lower Minimums Through Notional Funding

Tues. April 6, 2010—One of the main benefits of investing in managed futures is the ability to do so through notional funding, whereby you don’t have to put up a cash deposit equalling the program’s minimum investment amount in order to invest in that program. For example, it is possible to trade the $800,000 Mesirow Financial Commodities Absolute Return program with a cash deposit of just $100,000 to $200,000.

If you are saying, so what? … You can put up just a portion of the investment amount in all sorts of investments—stocks via a margin account, real estate via a mortgage, art via a credit card—you are missing the one big difference. That difference is that there is a cost to buying stocks on margin or purchasing real estate with a mortgage. That cost is the cost of money, or the interest rate you pay to borrow the funds for the investment you are interested in.

With notional funding, there is no borrowing of money and therefore no interest rate. How can there be no borrowing? Because we’re not talking about having someone assist you in getting your account to $800K to meet the minimum (or about trading a smaller version of the program with $200K), we’re talking about having $200,000 traded as $800,000 via the use of notional funding.

But as my old history professor would say, “that begs the question” what is notional funding? And when I answer notional funding is funding an account through the use of notional funds, he would again say, that begs the question what are notional funds?

NOTIONAL FUNDS

Notional funds represent the difference between a managed futures investment’s minimum investment amount and the amount of cash an investor is willing to put towards a managed futures program at that time. An investor may not have the full amount of the minimum or might wish to only put up a portion of the minimum and use the rest for another investment.

In a way, notional funds can be thought of as fictitious or imaginary money which is used to bridge the gap between the cash outlay an investor is willing to put towards a managed futures program at that time and the stated minimum amount of that program.

EXAMPLES

A quick example is probably the simplest way to describe it. Take the aforementioned Mesirow program with its minimum investment amount (at Attain; it is higher elsewhere) of $800,000. An investor does not actually have to have all $800,000 in her account in order to trade the program. Levels of notional funding vary between managers, but for this example, Mesirow will allow clients to use notional funds to cover up to 75 percent of the investment minimum.

That means the investor only has to have $200,000 in her account and can meet the minimum investment amount by pledging an additional, "imaginary" amount of $600,000. The actual cash balance plus the "imaginary," or notional funds balance equals the required minimum investment amount of $800,000.

Another way to think of how this works is to imagine having that $200,000 account, but telling the manager to trade is as if it was $800,000.

If you're asking "how in the heck can you use imaginary money" right about now, let me explain further.

To understand how an investor can use these imaginary, notional funds, we must first back up a step and examine how a managed futures advisor arrives at his or her minimum investment amount. Minimum investments could, or perhaps should, be further split up into three distinct levels, specified as:

1. The margin minimum: the technical minimum amount needed to actually place the trades on the exchanges.

2. The drawdown minimum: the amount necessary for an investor to withstand any eventual drawdown of the investment.

3. The window dressing minimum: the amount to make the percentage drawdowns and returns attractive to the greatest number of investors.

TECHINAL AMOUNT

The first part of the minimum investment amount—the amount technically needed to place trades—is what the exchanges and clearing firms refer to as the margin requirement. Any account that wishes to trade a futures contract on a regulated futures exchange such as the Chicago Mercantile Exchange must first have enough money in the account to cover the performance bond requirement of the exchange (the margin). This ensures that the exchange can make the trader who takes the other side of the trade good should the trade go against the account. (If Washington is serious about financial reform and removing too big to fail entities, all it needs to do is require all derivatives to be traded through an exchange, so that any losses are backed by performance bonds and covered by the exchange.)

Margins can sort of be thought of as the amount of money which could be lost on that position in a single day. And the exchanges and clearing firms make sure each account has that much money, or else the whole system doesn't work. If this wasn't in place, the loser could simply disappear and the winner would be left empty handed.

DRAWDOWN AMOUNT

The second part of the minimum investment amount—the amount an investor needs to withstand any eventual drawdown—is another technical level of sorts, in that an account must have at least that amount in order to stay above zero. If the investment has the possibility of losing $150,000, for example, in the normal course of operation, then an investor better have at least that amount in order to proceed.

If she didn't, she would have to get out of the investment during the normal ups and downs of the investment. Think of it like a tank of gas. If you are driving 100 miles and need 5 gallons of gas to get there, you better have at least 5 gallons of gas in the car.

WINDOW DRESSING AMOUNT

The third part of the minimum investment amount—the amount needed to make the percentages appealing to potential investors, or "window dressing" amount—is simply a subjective amount the advisor computes in order for the average returns and risk of his or her program to come out "nicely," for lack of a better term.

Imagine an advisor with average annual returns of $100,000 and drawdowns of $50,000. If that advisor sets his minimum at $100,000 then the average annual return in percentage terms is 100 percent with a 50 percent drawdown. If the advisor sets his minimum at $1,000,000, the average annual return in percentage terms is 10 percent with a 5 percent drawdown.

While the returns in dollars are exactly the same, the advisor would likely find much more success raising money with the $1 million minimum amount, because investors will ignore programs with large drawdowns such as the 50 percent drawdown number.

The difference between the desired minimum and the minimums needed for margin and drawdown is the window dressing amount, and it is often this amount which can be "notionalized".

See Figure 1 below for a look at what those levels would be for Attain Portfolio Advisor's Strategic Diversification program.

Understanding that up to 80 percent of a managed futures program’s stated minimum investment amount can be nothing more than window dressing gets us a step closer to understanding how you can use imaginary, notional funds, when investing in a managed futures program.

It should be clear that while an investor actually needs both the technical amount for margins and drawdown amount to stay alive, the investor doesn’t necessarily need the window dressing amount. If it is only there to make the returns and drawdowns more palpable for most investors; an investor who can stomach much larger percentage gains/losses (you will have the same dollar gains/losses) doesn’t need window dressing.

USING NOTIONAL FUNDING

For those investors who don’t require the window dressing, (those who can handle 3 to 5 times the percentage gains and losses), notional funding is perhaps the most efficient form of investing available to investors. Once investors understand that the window dressing amount is only to make them feel better about how much (in percentage terms) they have made or lost, they are free to take that window dressing amount and use it for other purposes.

For example, say you have a portfolio of $750K cash and $250K in stocks and find the $800,000 Mesirow program intriguing. But you aren’t willing to get out of your whole stock portfolio during the current market rally in order to fund Mesirow. Once you understand the notional funding, you don’t have to sacrifice. You can keep your stock portfolio intact, and put $200K into a futures account to trade Mesirow.

You will have taken on additional leverage (as you are now trading $750K in stock plus $800K in managed futures, for a total of $1.55 million in investments backed with just $1 million), but that has appeal for those investors who understand the risks associated with it.

Notional funding also allows for the trading of multiple managed futures programs with a single cash allocation. Assume the same investor above wishes to get out of stocks at these higher levels and put the whole $750K into managed futures. He could invest in just Mesirow with that amount, or he could use notional funds to diversify his managed futures investment into several programs. If on the aggressive side, our investor could trade a balanced managed futures portfolio of Mesirow ($800K), Paskewitz ($500K), Dominion ($1,000K), and Emil Van Essen ($500K), totaling $2.8 million in initial investment amounts, with just the $750K in cash.

This would represent leverage of roughly 3.7 to 1 in the account ($750K traded as $2.8 million), and the investor would see percentage gains and losses on his $750K that are 3.7 times what an investor putting up the full $2.8 million would see.

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