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April 6, 2007 8:12 pm

Hands-On Investor: Futures fund for the masses

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The futures market – a $100bn global marketplace for agricultural commodities, currencies, and bonds – is going mainstream.

Rydex Investments last month launched an open-end managed futures fund designed to offer retail investors access to the US commodity and global financial futures markets.

In the past, the high fees and minimum net worth requirements of managed futures funds kept them out of reach for all but the wealthiest individual investors. But Rydex – the Maryland-based company that has made its name bringing institutional-style investment strategies and techniques to the retail world – is betting that this relatively low-cost fund will attract smaller investors.

“One of our company’s major themes and objectives is to build out a slew of alternative investments within a mutual fund framework – and that’s exactly what we’re doing here,” says Edward Egilinsky, managing director of alternative strategies at Rydex. “This is the first time that I’m aware of that retail investors have access to managed futures strategies through a mutual fund structure that offers low minimums and daily liquidity.”

The aim of the fund is twofold, according to Egilinsky. “One, we want to give investors exposure to managed futures without structural limitations; and two, we want to bring to market asset classes that don’t correlate with stocks and bonds. According to our ‘essential portfolio theory’, when you blend alternative investments into a traditional stocks and bonds portfolio, you reduce risk and enhance return.”

The fund, which allows investors to trade shares daily, has no income or net worth requirements but, similar to other Rydex funds, has a minimum investment of $2,500. So far the fund has raised just over $60m, and Egilinsky says he hopes it will soon be one of Rydex’s signature funds for alternative investments.

The Rydex fund tracks the performance of the Standard & Poor’s Diversified Trends Indicator, which comprises 14 sectors split down the middle, with 50 per cent allocated to financial futures – currencies such as euro, yen and pound sterling – and 50 per cent allocated to commodity futures such as grains, livestock, precious metals and energy. The model rebalances monthly.

“Most of the managed futures industry is based on trend followers, and the S&P DTI relies on price trends,” says Egilinsky. “It’s a similar methodology that is rules-based and relies on trends to capture profits.”

Rather than investing directly in futures contracts – agreements between buyers and sellers to establish a certain price for items to be delivered in the future – the fund uses structured notes to mirror the daily performance of the S&P indicator.

The model has the capacity to go long or short based on price momentum, which enables the fund – in the words of Egilinsky – to “benefit regardless of whether prices are rising or falling”. The exception to this is the energy sector: because of political and economic issues, the S&P DTI only takes a neutral position.

One of the most appealing attributes of managed fut­ures as an asset class, says Egilinsky, is that they tend to perform well during bear markets. “[The S&P DTI] has historically shown a very low or slightly negative correlation to traditional investments such as fixed-income and equities and at the same time exhibits an attractive risk/return ratio,” he says.

According to figures from Rydex, from January 1985 through December 2006, the S&P DTI had a correlation of -0.078 to the S&P 500 Index and 0.038 to the Lehman Aggregate Bond Index. Indeed, over the same period, the S&P DTI returned 11.04 per cent with a standard deviation of 6.01 compared with the S&P 500 Index’s returns of 12.93 per cent at a standard deviation of 14.88 and the Lehman Aggregate Bond Index’s returns of 8.33 per cent at a standard deviation of 4.35.

In addition, the underlying commodity and financial components have little correlation with one another. “This is because commodities and currencies have characteristics that might impact [on] them differently,” says Egilinsky.

The price of cotton, for instance, has very little relation to the price of live cattle, which has little to do with the price of US Treasury notes. This makes for an investment model with a high level of “internal diversification”, he says.

A typical managed-futures fund charges management fees of 2 per cent of assets in addition to sizeable performance-based fees. The Rydex fund charges annual expenses of 165 basis points, which represents a higher fee than the average mutual fund but is reasonably priced for an alternative investment.

Some advisers have also pointed out that fees related to buying structured notes – such as execution costs – are not reflected in the expense ratio but could put a dent in returns. These fees could run up to 1 per cent to 1.5 per cent of fund assets.

Egilinsky, however, says concerns over costs are outweighed by the access to the asset class the fund offers. “This fund is for any investor looking to diversify, and looking for capital appreciation,” he says.

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