Rydex Investments hopes to move beyond market timers to mainstream advisors.
Bryce James, who designs asset allocation strategies
for institutional clients, disagrees with the way many financial
advisors allocate assets.
"The traditional stock-to-bond to cash split is nowhere close to the
reality of how a portfolio should be deployed," says the president of
Smart Portfolios in Seattle, Wash. "What metric says you should only
put 5% of your money into noncorrelated investments?" James uses
inverse rate funds, inverse index funds, commodity-linked funds,
leveraged funds and other products to design strategies that often
place greater emphasis on nontraditional investments than conventional
asset allocation models.
Like flat-screen televisions or online dating
services, investment strategies once considered radical are now moving
toward the status quo as the financial services business pumps out a
growing roster of hedge-like mutual funds, investments linked to
commodities and currencies, long/short funds, and other once-exotic
vehicles. Rydex Investments, a firm that specializes in such "off the
beaten path" products, is capitalizing on the growing demand for
alternative investments by expanding the niche it developed more than
12 years ago.
"They were the first to take the road less
traveled," says James of the firm. "When most of Wall Street was busy
introducing 'me too' stuff, they didn't go with the status quo."
Founded in 1993 by the late Skip Viragh in borrowed
office space and with two employees, the Rockville, Md., firm was the
first fund company to use leverage for equity and bond funds, and the
first to offer inverse fixed-income and inverse equity funds. Today, it
manages approximately $13 billion in 51 mutual funds, including two
ETFs and a fund of hedge funds.
While some of those products are designed to enhance
or amplify returns in a bull market, the major draw over the last
several years has been in noncorrelated investments that can be used
for hedging traditional stock and bond portfolios, says Rydex chief
executive officer Carl Verboncoeur, who assumed his position in 2003
after Viragh stepped down for health reasons. These include several
inverse index funds, an inverse bond fund, and both closed-end and
open-end mutual funds that employ hedging strategies.
"We've always had a niche among advisors, and with
the increasing popularity of alternative investments we have the
opportunity to expand that niche," says Verboncoeur. "A sideways market
that could be around for the foreseeable future has created a tailwind
for us."
The question now is whether the firm can get on the
radar screens of more mainstream advisors than it has in the past. With
its liberal redemption policies and sophisticated fund lineup, many of
those drawn to the fund complex's offerings early in its history have
been market timers who traded in and out of mutual funds as a major
part of their strategies. Now, that's changing. "Our shareholder base
has evolved, particularly over the last three or four years," says
Verboncoeur. "Today, we're seeing more strategic advisors who combine
buy and hold with tactical asset allocation and alternative investing."
These advisors are attractive to Rydex because they represent stickier
assets that won't vanish regularly into a third-party platform
provider's money market fund or whip through funds faster than a Kansas
tornado.
The shift comes as the firm looks back on net
outflows of $740 million for 2005, according to Financial Research
Corporation in Boston. Much of the bleed came from inverse bond fund
Rydex Juno, which posted negative returns last year as long bond rates
unexpectedly held their ground. By comparison, Rydex had net inflows of
$3.7 billion for all of 2004 and $2.7 billion in 2003.
Getting "Tactical"
The "tactical" asset allocators the firm is courting
these days do not necessarily fit the classic market-timer mold. Some
use alternative investments as a sleeve component of their portfolios
that accounts for only 10% or 20% of assets. Others may use a
traditional buy-and-hold approach, but reserve a portion of their
portfolios for more active investing designed to capitalize on
short-term market conditions.
Rick Gage of Strategic Equity Management in
Scottsdale, Ariz., uses Rydex funds for core and satellite strategies.
He combines 70% to 80% of a passive core portfolio, consisting of
traditional stock and bond asset classes, with a 20% to 30% mix of
active satellite investments. The satellite part of the portfolios
often includes hedges or noncorrelated investments. Gage says the
approach is designed to help smooth out returns and keep clients
comfortable with an investment plan over the long run. "A hedged
portfolio may not keep up in a strong bull market," he admits. "But
I've found that if you lose less in down periods, it adds a comfort
factor."
According to a recent study from Rydex affiliate
AdvisorBenchmarking, the number of tactical advisors like Gage is
growing. Nearly 16% of advisors surveyed said they had "become more
tactical asset allocators" in 2004, compared with 7.3% who made such a
transition in 2003. Overall, 40% of advisors surveyed described their
investment style as "tactical." Most said they still created long-term
strategic asset allocation targets, but combined them with periodic
adjustments for the asset mix based on short-term market adjustments.
Despite the reported shift in attitude, the road to
carving a bigger niche in the advisor market may not be smooth. Many
advisors continue to rely on traditional asset allocation models, and
some question the effectiveness of more aggressive techniques such as
the use of leverage to magnify returns, inverse investments, frequent
trading and short-selling.
"We're not a trading firm and we don't make active
bets," says Rick Ferri of Portfolio Solutions, whose Troy, Mich.-based
firm manages $600 million in assets. "We put together long-term,
long-only portfolios and rebalance them once a year." Ferri, who uses
passive investment strategies that he implements with index funds and
exchange-traded funds, feels that fund firms often overstate the
usefulness of noncorrelated investments to promote sales.
Even advisors who are open to the idea of expanding
their alternative investment horizons may already be doing so through
well-known funds such as Baron Partners and Leuthold Core Investment
Fund, which have the authority to hedge against market fluctuations. As
of September 30, the mutual funds tracked by Morningstar that use hedge
fund strategies managed $12.7 billion, up from $4.6 billion two years
ago, and more fund companies plan to introduce offerings with similar
strategies.
Rydex also faces competitive challenges from
ProFunds and Potomac, two smaller players in the alternative-investment
mutual funds space. In August, ProFund Advisors signaled its intention
to enter the exchange-traded funds business by hiring Gus Fleites as
chief investment officer and head of ETFs. Fleites, formerly a senior
principal of State Street Global Advisors, was previously president of
SSgA's streetTRACKS family of ETFs. Chairman and CEO Michael Sapir says
he can't discuss anything currently in registration, except to say that
his firm "intends to offer products that will fill needed spaces."
Meanwhile, Potomac reports strong interest in such
offerings as the Commodity Bull Fund, which invests in commodity-linked
derivative instruments. Like Rydex, however, both ProFunds and Potomac
have seen net outflows in 2005, according to FRC.
A new campaign designed to get advisors to take a
second look at the way they allocate assets may help Rydex distinguish
itself in an increasingly crowded field. In October, the firm announced
the introduction of Essential Portfolio Theory, an investment approach
that, according to the firm, is designed "to help investment advisors,
brokers and investors understand the dynamic nature of modern markets
and learn how to potentially increase portfolio diversification and
manage risk." Among other things, EPT advocates "expanding traditional
stock/bond/cash asset allocation to include asset classes with positive
and negative correlation to the market, such as commodities, futures,
real estate, inverse investments, hedge funds and leveraged or currency
products."
It is also increasing emphasis on packaged products
aimed at advisors who want to use tactical asset allocation and
alternative investments but don't want to devote the time necessary to
monitor such strategies. These include two open-end hedged funds
launched in the fall, the Rydex Absolute Return Strategies Fund and the
Rydex Hedged Equity Fund. The Rydex Absolute Return Strategies Fund,
benchmarked to returns of the broad hedge fund industry, invests in
stocks, bonds, commodities, currencies and options. It also uses
market-neutral, merger arbitrage and fixed-income, duration-neutral
strategies. The Rydex Hedged Equity Fund, designed to mimic returns of
long/short funds, invests in equities and options and uses
market-neutral and merger arbitrage strategies. The new offerings join
Rydex SPhinX Fund, a closed-end hedged fund-of-funds that equally
allocates assets across 41 different hedge fund managers.