Rydex & ProFunds: Enhanced Funds Defined & How to Use Them
Traditional index mutual funds pose three problems for active investors and traders.
First, these funds only allow you to match their underlying index, minus management fees, possible loads and redemption fees, and other costs. What if you want to beat the index?
Second, the market falls as well as rises. When it’s down, you lose money. Your fortunes fall as well as rise with the index. Meanwhile, traders who short securities stand a chance to profit, often on the very same stocks your fund holds.
Third, your fund house may impose redemption fees and set up other obstacles to discourage you from shifting your cash between different sector funds or money-market funds. This can prevent you from effectively managing your money in anticipation of market movements.
For years, these restrictions have hampered traders and active investors who seek to time up and down markets and employ sector strategies that continually rotate their capital into the hottest sectors.
If you fall in this category, someone has heard your pleas. Two fund houses have led the pack in creating “enhanced” mutual funds to that go beyond the bounds of traditional index funds. They are the ProFunds and Rydex families.
These investment companies allow you to move your assets among their fund offerings as often as you wish, free of loads, redemption fees or other barriers to active investing. Rydex and ProFunds also offer funds intended to “go long” the market, in other words, benefit from a rise in their underlying indexes, and to “short” the market, in other words, profit from a decline in the indexes. And they also offer leveraged funds that exceed the moves in key indexes.
Buy-and-hold investors have discovered these funds as well as traders. Investors who stuck it out in leveraged funds based on the Nasdaq 100 and S&P 500 indexes were well rewarded in the latter 1990s.
But these funds are not for those with a low tolerance for risk. Remember that leveraged funds will multiply losses in bear markets just as they will multiply gains in bull markets.
Little in this world comes for free. Rydex and ProFunds do charge operating fees to cover their expenses and management fees. The ProFunds UltraOTC Fund, for instance, was running annual total expense ratio of 1.2% of assets in February 2000, including a 0.75% management fee. The Rydex OTC runs a 1.15% expense ratio, including a 0.75% management fee.
Like virtually all fund families, Rydex and ProFunds provide money-market funds to serve as the cash-equivalent safe haven for investors assets.
ProFunds offers long and short funds, plus funds that use margin to get as much as double the moves off their underlying indexes. This will double your gains over the index when the market is trending higher, but of course, a market decline will double your losses as well.
As of the end of February 2000, ProFunds managed an ordinary S&P 500 index fund, the obligatory money-market fund and 10 funds that attempt to double their underlying indexes on the long or short end. An 11th enhanced fund, UltraShort Europe, was closed to investors on Feb. 28.
“We don’t see that there’s any magic to only matching an index,” said Michael Sapir, chairman and chief executive officer of ProFund Advisors LLC, adviser to the ProFunds family. Sapir, who was involved in the creation of the first “prime rate” fund, played an instrumental role in developing the Rydex funds.
“A fund that matches an index has a beta of 1 to the index. If the index goes up 1% or down 1%, the fund will move in the same direction by the same amount,” Sapir said. “We created funds that looked to double the index on a daily basis, funds that have betas of 2 to their indexes. If an index moves up 1%, the fund moves up 2%. If the index moves down 1%, the fund moves down 2%.”
In a bull market, this kind of high-octane fuel can produce breathtaking results. Just don’t let it burn you in down market! UltraOTC, which doubles the Nasdaq 100 Index, opened for business on Nov. 26, 1997. In its first two years of operation, Ultra OTC’s Net Asset Value (NAV) soared 850%.
If doubling your bets sounds like too much to handle except under the most promising market conditions, you can easily adjust your exposure through asset allocation. Sapir calls this “dialing a beta.”
For example, let’s say you have $10,000, and you decide felt conditions favored a gain in the S&P 500, but you could only stomach a beta of 1.5. The UltraBull ProFund will double the moves of the S&P 500. So you would leave 25% of your capital — in this case, $2,500 — parked in your ProFunds money-market fund. You’d invest 75% of your cash — $7,500 in this example — in the UltraBull ProFund.
ProFunds also corresponding offers funds that short key indexes. The short funds gains or losses will be double the inverse of the gains or losses of their underlying indexes. For example, the UltraShort OTC would rack up a 2% NAV gain if the Nasdaq 100 fell 1%. The fund would lose 2% if the Nasdaq 100 rose 1%.
You can regulate how aggressively or cautiously you want to play the bear moves just as you would playing the bull moves. “We allow you to pick anywhere you want to be on the spectrum — from +2 to -2 — anywhere in between,” Sapir said.
The minimum investment for an individual to open an account with ProFunds is $15,000. Rydex sets the minimum ante at $25,000.
The Rydex family similarly enables you to “buy” or “short” the market through enhanced funds. For example, ^RYVNX^ has a target beta of 1.5 to the S&P 500. By comparison, ^RYURX^ shorts the S&P 500 stocks in an effort to profit from declines in the index.
^RYOCX^ aims to track the Nasdaq 100 while the Rydex Arktos
^RYAIX^ shorts securities to inversely correlate to the index.
The Rydex family also offers a wide spectrum of sector funds. A few of the sectors covered include banking
^RYKIX^, basic materials
^RYBIX^ biotechnology
^RYOIX^, consumer product
^RYCIX^, technology
^RYTIX^ and telecommunications
^RYMIX^.