Sophisticated investors want solutions, not product-oriented approaches. That's the message Sanjay Yodh gets from advisors when they vet Rydex/SGI on behalf of their wealthy clients, and he's delighted to hear it. Solutions, he says, are what the new firm, a merger of Rydex Investments and Security Global Investors, is in a perfect position to deliver.

"[The merger] elevates our game," says Yodh, head of the Rydex/SGI alternative product line. "Now we can discuss how we think about traditional approaches and alternative approaches and the combination of the two."

SGI and Rydex, sister companies under the Security Benefit Corp. umbrella, merged in January 2009 with the goal of building a new entity that combined Rydex's expertise in bringing institutional-style investments mainstream and SGI's institutional-quality asset managers. The combined firm has $21 billion under management.

"SGI is predicated on fundamental, bottom-up research [and] alpha-driven strategies; they were born in the institutional landscape," says Yodh. "Rydex has traditionally offered quantitatively driven trading strategies that are more beta in orientation."

Now, the combined firm is able to create the right combination of alternative alpha and alternative beta, and everything in between, says Yodh. "There are bridges to alpha and beta we're thinking about today," he says. "The core competencies of these organizations coming together allow us to do  it in a more seamless manner. We've already launched strategies in that vein, and we continue to look at strategies that are offshoots of current ones or that are entirely new."

Highest-End Clientele
Part of Marc Zeitoun's job as the firm's head of distribution is to explain Rydex/SGI's alpha-oriented equity strategies and its liquid alternative investment strategies to potential investors. His approach to the marketplace is decidedly new. "We have said that we wish to cater to a certain element of the population because our solutions make the most sense to them-single family offices, multifamily offices, trust banks, very high-end advisors who do institutional consulting," he says.

Zeitoun says Rydex/SGI has a number of competencies-a major one being its alternative suite-with potential benefits that require a certain level of sophistication to be fully appreciated. "If it were only about returns, we would just wait for money to fly in based on Morningstar reports," he says. "We need to awaken sensitivity to liquidity within our client base and show them it's possible to construct very thoughtful and intelligent portfolios with exposures to different classes while not threatening the necessary liquidity of that portfolio. I understand that single family offices don't necessarily manage to liquidity, but unfortunately, when they end up having too much illiquidity, their clients get upset."

When Zeitoun introduces Rydex/SGI to single family offices, high-end RIAs and private trusts, he has several competitive advantages on his side. "One thing is that no one knows us. We are truly new in this high-end private client market; we haven't been managing individuals' money to the point of losing it in 2008," he says. "Our management style on the value side is very focused on downside risk management. Over the last five years, we outperformed 86% of our peers in down markets. That kind of thing resonates with advisors."

Zeitoun says capital preservation is a very important investment objective at the highest end in client segmentation. "It's not a traditional retail investment objective of wanting a 35% return year after year; they care very much about how managers perform on the downside," he says. "People are looking for capital preservation, but not at the expense of growth. Our value competency is just as impressive on the upside, having outperformed another 80% to 90% of its peers over a five-year period, but we strike a chord with capital preservation and defensive equity management."

The value strategies seek investment opportunities in which a company's current stock price is materially lower than Rydex/SGI's internal assessment of the firm's intrinsic value. The value team is a long-term investor, seeking companies that can create value over the next three to five years. It uses a bottom-up approach in picking stocks. The team sells a company when its expected value is reached, when a change in the investment thesis occurs or when a new name presents significantly more upside.

Niche In Commodities
Rydex/SGI offers several products in the alternatives space, including a multi-hedged strategies fund, a replication hedge fund, an alternatives strategies fund and a fund of funds.

The firm's largest and best-known product is its flagship Managed Futures Fund, which has amassed some $2 billion in assets since it was launched in 2007, says Yodh. The fund is based on the Standard & Poor's Diversified Trends Indicator, an index comprising a total of 24 commodities in 14 sectors, equally divided between physical commodities and financial futures. The index is "managed" in the sense that it uses quantitative trend-following indicators in deciding to go long or short in a particular sector. An investment committee at S&P oversees management. The index uses a seven-month moving average for each sector. If the price of a commodity-or the aggregate price if a sector includes more than one commodity-is equal to or above the seven-month moving average, that's a signal to go long. A price below that average is a signal to go short.

Sector weights on the commodities side of the index are determined by world production figures. Those on the financial side of the index, which are basically country exposures as well as U.S. Treasury exposures, are determined by world share of GDP. The only discretion the management team exercises is to slightly alter sector weights to account for such things as liquidity and investability.

To control risk, energy is the one commodity sector in the index that is never shorted. This is because the sector can be subject to sudden, sharp price spikes due to the nature of the commodity, cartel production and geopolitical considerations. If the price indicator for energy is below the moving average, the energy weight is zeroed out and weightings redeployed pro rata across the remaining sectors of the index.

On June 25, Rydex/SGI moved deeper into the commodity space, rolling out the Long/Short Commodities Strategy Fund, which uses a more aggressive strategy that is designed to complement the Managed Futures Fund. "Our Managed Futures Fund, generally speaking, has 50% exposure to the commodity landscape, and as a portfolio takes on a bit of a defensive posture, which means it's a low volatility and volatility-dampening strategy," says Yodh. "We thought that in creating a long/short commodity fund, we could create a more offensive strategy and do it in a more efficient way in terms of managing risk, by allowing us to go long and short."

The new fund complements the managed futures strategy in a couple of ways. First, it trades at the component level, whereas the managed futures fund trades at the sector level (precious metals and agricultural products, for example). "In the Managed Futures Fund, we will either be long all the precious metals we have exposure to or short all of them," says Yodh. "In our commodity long/short strategy, we wanted to be able to say that, at any given point if we want to be long gold and short silver, we should have that ability."

Second, the management team believed that if the fund was going to have discrete commodity exposure, it had to be able to short the energy sector or any of its individual components. For example, the long/short fund could long West Texas Intermediate crude oil and short natural gas, which historically have very different supply-and-demand and directional price profiles.

The Rydex/SGI team worked with JPMorgan to create an active index that aims to match the performance of the JPMorgan C-IGAR Sigma Index, which seeks to capitalize on rising and falling commodities prices. Signals associated with the index allow it to be all long, all short, long and short, or all in cash, says Yodh. "That means we don't have to be exposed to any individual component if our methodology indicates there is no discernible trend to capture in that component," he says.

The managers adopted a volatility cap measure in order to mitigate commodities' tendency to have spikes in volatility. When they rebalance the portfolio each month, they review the standard deviation on a one- and three-month basis. If at any time during those two periods the standard deviation is greater than 20%, they reduce exposures in the portfolio to bring the rate below 20%. They also added a stop-loss-like mechanism into the index. If any component loses more than 10% in value, they will go to cash on the rebalance.

The new fund equal-weights the portfolio, while most commodity strategies production-weight their portfolios, says Yodh. Thus, the fund limits oil or energy as the driver of the commodity strategy, instead making it an equal component relative to, say, soybeans or corn or copper or gold. The fund also does a midmonth rebalance, which is a diversifier relative to the end-of-month rebalance and beginning-of-month reposition carried out by most '40 Act commodity mutual funds.

"Having the ability to deliver institutional-like strategies in '40 Act form is a wave of the future, and we are at the cutting edge of that," says Yodh. "Can I create a sophisticated strategy that is appropriate for both the institutional and the retail audience? The apex of that is where we want to be."