Lee Eugene Munson's  Instablog

Lee Munson and Lorn Davis provide independent fund research on Rydex Managed Futures Strategy Fund (RYMFX).

Alternative strategies and assets in mutual funds can provide relief from the US equity markets for investors’ portfolios. The Rydex/SGI Managed Futures Strategy Fund (RYMFX) is an opportunity for investors to take part in that relief by adding exposure to commodity and currencies in a long short environment. RYMFX is one of the first funds to track the relatively unknown S&P Diversified Trends Indicator, a long/short momentum strategy in the major futures markets that has been strong in delivering non-correlating returns over the past 10 years. Investors utilize managed futures strategies to reduce risk in their portfolio by being uncorrelated with the stock and bond markets.

This doesn’t mean you lose the risk return element, but it does mean it is divorced from the daily movements of stocks and bonds. Managed futures strategies also provide some inflation protection by investing in trending markets (things that are going up) as well as in hard and soft (i.e. the paper stuff) currencies. This is not about beating the stock market, or doing well when the S+P 500 tanks. The track record proves it has the ability to produce results on a year-to-year basis with low volatility thanks to the long/short strategy. Since it’s inception in early 2007, RYMFX has produced 10% compared to the S&P 500’s loss of 30%. Granted, this does not tell the whole story, but can show what marching to the beat of your own drum can do.

Since investors are paying RYMFX to track the S&P DTI, it would be a good idea to understand that index. The S&P DTI consists of 24 liquid futures contracts split up 50-50 between commodities and financials and further subdivided into 14 sectors. Before you fall asleep, just keep in mind the basic premise of the DTI. Prices of financial and futures contracts have a tendency to be cyclical in nature, each month the sectors are picked to be long or short dependent upon price action relative to the exponential moving average, theoretically giving the S&P DTI the ability to be profitable in up and down markets. The weightings of each sector are determined monthly by global production for commodities and GDP tier for financials, while the components of each sector are rebalanced annually. In short the S&P DTI is prescribed in so far as it only selects components that meet specific criteria and are at the top of the list, with the goals of low volatility and being highly liquid. So, while there is movement during the year, this is a more passive strategy than a hedge fund. Also, its something we can understand and follow. However, this is designed to be a long-term investment versus a short term trading vehicle.

RYMFX charges a total expense fee of 1.88%. While that fee is in line with active small cap and international funs, it is pricy compared to the average index or domestic large cap fund. Outside of Rydex wanting to get paid, RYMFX primarily works by investing in structured notes that are only offered by investment banks with heftier price tags than the initial investment requirement for a mutual fund. The fund managers also must pick ETFs or other venues to get the exposure necessary to mimic the DTI’s daily progress. One of the particular vehicles used by RYMFX is a wholly owned Cayman Islands subsidiary in which the fund is allowed to invest up to 25% of total assets. The subsidiary is utilized to invest in futures contracts and other instruments unavailable to a mutual fund. This subsidiary adds to the management fee as well as to the other expenses of running and maintaining it. While we don’t like the arrangement, it is not outside the norm for hedge funds or commodity advisors. Other fees for such services as shorting (i.e. the short dividend fees) add to the expense rate. But ultimately there are limited options in gaining exposure to the managed futures strategies market and paying a slightly higher than average expense fee should be worth it for the reduced portfolio risk and consistent returns. One other caveat is that the fund is currently holding 60% in cash, raising questions about whether the management team has been working hard enough to expose your money to the futures market. Yet given the equity’s markets mood swings, RYMFX has the kind results that an investor would be looking for to help the bottom line of their portfolio. We are long this fund and plan on sticking with for the long haul. The only requirement is that they keep simulating the DTI index.

Full Disclosure: Long RYMFX