---
title: Understanding Notional Funding  | RJO Managed Futures
---

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# Understanding Notional Funding

In the right hands, notional funding can be a cash efficient tool with which to efficiently extract performance from a CTA. Used irresponsibly, notional funding can be a devastating mistake.

Notional funding is tool used by many managed futures investors to access a CTA program with cash allocations less than the CTA’s stated minimum investment. For example, if a CTA offers a minimum account size of $1,000,000, an investor might choose to fund the account with $500,000 of cash and $500,000 of notional funds.  In such an instance, the $500,000 cash deposited would be traded as if it were the full $1,000,000. The unfunded $500,000 (the notional funds) would effectively act as a placeholder from the CTA’s perspective.

The use of notional funding is possible because most often, the actualfunds required to maintain a managed futures account are significantly lessthan the CTAs stated minimum investment. For example, the $1MM minimum CTA abovemight typically use 10% of the trading level for margin, and might have regulardrawdowns of 15%. So in theory, 75% of a fully funded account should notbe necessary to maintain the account. However, this is a grossoversimplification. In practice, an investor should allow for a far broaderrange of margin usage and drawdown potential in order to avoid a margin calland potentially ulcer-inducing account value swings, based on the cash deposit.

It is also very important to be aware of the effect that the use of notional funding can have on the percentage profits/losses on the actual funds invested. In the example from the first paragraph, when funding a $1,000,000 account with $500,000 a 15% profit/loss on the fully funded account would result in a 30% profit/loss on cash.

While past performance is not indicative of future results, the historical performance and margin usage of the CTA must be closely examined if an investor is considering the use of notional funding. As stated above, the cash actual investment should be based on realistic expectations of margin usage and drawdown potential. The question becomes how to arrive at reasonable figures for each, and whether to also add a ‘cushion.’ Using the CTA’s past monthly performance, perhaps from the CTA’s disclosure document, will NOT provide a reasonable expectation for drawdowns. For example, a CTA may have posted a 4% drawdown for a particular month and this might represent the worst monthly loss in their track record, but this does not reflect what may have occurred intra-month. The CTA may have been down 15% midmonth, only to climb back to -4%. In this case, -15% is the far more important figure to consider. Just as important, -15% may not be an appropriate number to use, as the CTA may feel the program is capable of even bigger hits.

Likewise with margin usage. CTAs most often post AVERAGE margin usage, but it is vital to understand what a maximum might be. For example, a CTA might state average margin usage of 10%, but might occasionally use as much as 25%. With both margin usage and drawdowns, it is incredibly difficult to develop reasonable expectations without speaking directly with the CTA and/or their broker for greater depth of understanding.

In the simple example presented, a client may have initially thought 25% (margin plus drawdown) was appropriate. Upon further investigation, that client learned that a 15% drawdown and 25% margin (total 40%) were better figures. Taken a step further, a client that posted only 25% to this fictitious CTA had possibly/probably exposed the account to a 15% or $150,000 margin call in the future.

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