The only justification for mutual funds to have higher fees than ETFs is "active" management that leads to outperformance. How can a fund that has significantly worse holdings than its benchmark hope to outperform? After all, it's the performance of a funds' holdings that drive the performance of a fund. The Rydex Series Real Estate Funds (MUTF:RYREX) (MUTF:RYCRX) (MUTF:RYHRX) are in the Danger Zone due to alarmingly poor holdings and overly high fees.
Poor Holdings Makes Outperformance Unlikely
Investors in Rydex Series Real Estate Fund are paying a fee with the hopes that the fund manager can allocate to a better basket of stocks than can be found in its ETF benchmark, the iShares Mortgage Real Estate Capped ETF (NYSEARCA:REM). Rydex is giving investors very different asset allocation than the benchmark. Unfortunately, that asset allocation is much worse.
Per Figure 1, Rydex Real Estate Funds allocate 54% of assets to Dangerous-or-worse rated stocks while REM allocates just 12% of assets to Dangerous-or-worse rated stocks. On the flip side, REM allocates 26% of assets to Attractive-or-better rated stocks while RYREX allocates only 8% to Attractive-or-better rated stocks. If, Rydex Series Real Estate funds holds worse stocks than REM, then how can one expect outperformance?
Figure 1: Rydex Real Estate Fund Portfolio Asset Allocation
Sources: New Constructs, LLC and company filings
The 2nd Most Expensive Fund Under Coverage
With total annual costs (TAC) of 6.76%, RYREX is the second most expensive fund of the 849 sector ETFs and mutual funds under coverage. RYCRX (TAC of 5.77%) and RYHRX (TAC of 4.89%) also rank within the top 10 most expensive sector funds. More details can be seen in Figure 2. For comparison, the benchmark, REM charges total annual costs of 0.53%.
Figure 2: Rydex Real Estate Funds' Understated Costs
Sources: New Constructs, LLC and company filings.
Over a 10-year holding period, the 5.16 percentage point difference between RYREX's TAC and its reported expense ratio results in 65% less capital in investors' pockets.
To justify its higher fees, the Rydex Real Estate Funds must outperform its benchmark by the following over three years:
- RYREX must outperform by 6.2% annually.
- RYCRX must outperform by 5.21% annually.
- RYHRX must outperform by 4.33% annually.
The bottom line is that with such high costs, it is highly unlikely that these Rydex managers will ever outperform their much cheaper ETF benchmark.
The Importance of Proper Due Diligence
One thing we've learned while analyzing tens of thousands of company filings over the past twenty years is never underestimate how wild or bad disclosures may be. As soon as you say, "there's no way a company would do that…" we find a company that has done that. The same is true for mutual funds. That is why, each quarter, we provide investors a guide to finding the best mutual funds and avoiding the worst mutual funds. Only performing proper due diligence can help avoid funds like RYREX, that not only hold low quality stocks, but also charge investors significant fees to do so.
Without proper analysis of fund holdings, investors might be overpaying or disappointed with performance.
Disclosure: David Trainer and Kyle Guske II receive no compensation to write about any specific stock, sector, style, or theme.
Disclosure: I/we have no positions in any stocks mentioned, and no plans to initiate any positions within the next 72 hours.
I wrote this article myself, and it expresses my own opinions. I am not receiving compensation for it. I have no business relationship with any company whose stock is mentioned in this article.