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Before joining Rydex, Byrum was a broker with Money Management Associates, the registered investment advisor to Rushmore Funds, Inc. He earned his bachelor's degree in finance from Miami University of Ohio. He is a Chartered Financial Analyst, as well as a member of the Association for Investment Management and Research and the Washington Society of Investment Analysts. Working Money Staff Writer David Penn interviewed Byrum via telephone on April 9, 2001, asking him what we have to look forward to in the next 12 months. His answer may surprise you.
As far as stocks go, it's most important to understand the risks and whether the risk associated with investing in stocks works with what you're trying to accomplish.
As the chairman of the Investment Strategy Committee for Rydex Funds, what kind of responsibilities do you have? The committee is responsible for the oversight of our funds on a daily basis. The committee meets formally three times a week. We have formal performance reviews, and we are also involved in making investment policy decisions for the funds. We also oversee product development activities. As committee chairman, I'm responsible for driving the agenda and leading the other members of the committee to make sure we're covering all the important topics. As far as the investment process goes, we are directly involved with all the mutual funds managed at Rydex.
How are the funds themselves managed? We've segmented the funds into two distinct areas, the sector fund group and the benchmark fund group. The group leader or senior portfolio manager for each area reports to me. Most of our funds are team-managed, but we do have some with named managers. One of our strong points is that we play off one another to find the most efficient solutions and to improve our investment process. The Investment Strategy Committee is responsible for making policy decisions and reviewing the performance of fund management teams. The portfolio management teams are responsible for the daily operation and successful management of a particular fund by making sure it's meeting its objectives -- matching its benchmark returns, for example.
Is there any philosophy or overall investment approach that governs Rydex as a fund family? Yes. At Rydex we manage our funds using quantitative methodologies, which means we take a highly structured and disciplined approach to investment management. Our goal is to keep the funds fully invested at all times. We don't try to call the market by raising cash. We try to minimize risk relative to specific benchmarks while incorporating strategies to outperform them over time.
What makes quantitative money management different from any other kind, aside from not calling market direction? Quantitative money management is a highly structured, generally nonbiased method of managing money. It's based on mathematics, as opposed to more subjective, "kick-the-tires" stockpicking type of management.
Is there any tire-kicking in the process? Not in the traditional sense. From a research standpoint, we are very well informed. We have a lot of information coming to us such as the business models of companies and so forth, but we're not stockpickers. We don't have fundamental analysts who are trying to work the numbers and determine the growth rate of particular companies. But we're not completely passive in our approach, either. We don't merely buy whatever's in the benchmark. We just fall closer to indexing than fundamental analysis or stockpicking.
Was there an ideological reason for pursuing a quantitative approach as opposed to a fundamental one? We're not out to judge different approaches to investment management, but we do try to play into our strengths. When we started the firm back in July 1993, we recognized that it would be difficult for us to replicate something that, say, a Fidelity fund manager could do. We would have had to hire dozens, if not hundreds, of analysts to perform fundamental analysis on a select universe of stocks. That simply was not practical. We decided that by taking a more passive approach -- but not entirely passive -- and finding ways to add value, we would have much more success. So we gravitated first toward an index-based, then quantitative-based investment style.
Is that style the best way to invest? I think all different approaches to investing are potentially appropriate. There's an ongoing debate over active management versus passive. That's a debate that we can certainly tune into. Over time, you're probably better off in a more passive vehicle, because active managers can't generally outperform the benchmark consistently. Every now and then, you'll find something unique, but on average, it's going to be more of a losing proposition. From an academic standpoint, we naturally gravitate toward passive management techniques.
Could you tell us about the Ursa fund and how you came up with the idea of launching what seems to be a bear market type of fund? I wouldn't characterize Ursa as a bear market fund, and I'll tell you why. The fund is useful for a lot of different strategies. One of them, which is important not to discount, is that it gives investors the opportunity to hedge.
Why is that important? Because typically you're going to want to hedge when things are a little more exuberant than you're comfortable with. That would suggest that as the market was climbing rapidly, certain investors -- and we've witnessed this with our shareholder base at times -- would move a portion of their money out just so they can say, "Hey, I'm going to lock in some of this gain, just in case." When that happens, it's time to take a hard look at a fund like Ursa.
The other side of the coin, of course, is when things are in a downward trend. The Ursa fund is useful when you're speculating a bear market scenario. Putting the fund into a box that only works in one market environment detracts from its usefulness. This is the reason Rydex has 31 funds and an extremely flexible exchanging policy. We have funds for every market.
You talked about these funds becoming particularly attractive when you reach exuberant points in the market. Was the idea for Ursa to serve as a hedge fund? Yes, in a way. When we approached it, our founder, Skip Viragh, conceptualized Rydex Funds as a family of mutual funds that catered to the needs of investors. We were specifically targeting the registered investment advisors (RIAs) or institutional investors who used mutual funds to manage client assets. But over time, we found that we had a good retail following, so we ended up not only catering to institutional needs, but also to a number of more sophisticated retail shareholders, who have used our funds to have more flexibility in their accounts. We've seen retail shareholders using an Ursa fund to hedge against a potential downside in the market without having to sell out an entire long position. We've also seen investors use these funds as a tax strategy, or to avoid creating a taxable event.
What about the strategy of the inverse correlation to the Standard & Poor's? Is that an example of what you were talking about before in terms of the quantitative approach as opposed to the stockpicking approach? Yes, it is. Betas, alphas, and correlation are part of quantitative money management. Our benchmark is a -1 beta, if you will, or an inverse correlation to the S&P.
Do you use other investment products to pursue that strategy? Absolutely. Especially with the Nasdaq 100, or in the case of the Ursa fund, the S&P 500. There are so many different opportunities to gain exposure or short exposure to that index, whether it's futures, options, stocks; our investment model incorporates everything possible. We determine what the most efficient means are at any given moment in time to achieve the exposure we desire. We bring to the table the ability to make sense of all the dynamics going on. At any time, futures could trade at a significant premium or discount to the underlying stock, or vice versa. It's a dynamic model.
Rydex Ursa Fund (RYURX)
So you're accommodating playing with options and futures in a format that's less active than most funds that take advantage of futures and options? Right. We're not predicting market direction. Let's say you break up the world into relative return strategies and absolute return strategies. A relative return strategy means your investment is structured to act and perform like its benchmark. In an absolute return strategy, you are purely performance driven. That is, you don't evaluate your returns based on anything other than the absolute performance. We tend toward the relative return side of the fence.
How do you determine that? A lot of it is determined by just how closely you want to match a particular benchmark. Index funds, for instance, want to match a benchmark precisely. These days, active managers need to beat the S&P, but they can't in a lot of ways. They feel like they can't lose too badly to the S&P. It's a bad situation for active managers. They're still concerned about what the benchmarks are doing. We want to look pretty close to what that benchmark is, but don't necessarily need to match it exactly. We have some flexibility. That's where active management comes into play. But still, we're much closer to being passive managers than anything else. Consistency of performance - giving our shareholders what they expect - is very important to us. We're never going to go too far out on a limb in making any bets outside the benchmark.
Rydex Arktos Fund (RYAIX)
So you are interested in giving your shareholders what they expect, although it might not necessarily be the most high-flying fund at any particular point? Investors get a superior benefit if they have some sense of what they can expect out of the fund, don't they? I agree. That's what drives our business model: making sure we deliver what's expected. We benefit from that, and our shareholders praise us for coming very close to our targets.
You talked about the Arktos fund briefly - that's the Nasdaq 100 - and the Ursa deals with the S&P. Do you have different strategies for the Ursa and the Arktos? Or can you pursue a similar approach with both funds? There are differences and those are mainly driven by the different liquidity structures of the two markets. The S&P 500 generally is more liquid, especially the S&P 500 futures relative to Nasdaq 100 futures. So in some ways we have more flexibility and more opportunities with the S&P. But the Nasdaq 100 is reasonably liquid. Liquidity influences the model allocation, but it doesn't have a dramatic influence. We're still using the same instruments.
What are some of the characteristics you look for in terms of putting together the funds? Liquidity, for one. In our model, as I was saying before, we look at all the different instruments available. There are two sides to the equation. One is what we can trade most efficiently, and the other is the cost of carrying a position over time. That's going to change. Sometimes, it's more cost-effective to own a synthetic exposure to the index -- using futures only. At other times, it makes more sense to own stocks. And that depends on the motivations of all the other market participants. How are their portfolios positioned? Are they short stock? Are they long stock?
Are there other criteria? It's also a function of the cost of rolling over the futures contracts, which changes over time. So you have the trading side of the equation and the cost of carrying a position. A third component is the regulatory side. When you start talking about running a 1940 Act mutual fund, you have to make sure that you conform to all appropriate rules and regulations. It's a dynamic environment. It's a function of the supply and the demand and the liquidity in the marketplace. We try to capture all of those elements in as much of a real-time model as possible.
What are your thoughts about the market as it stands now? It's been a tough 12 months, hasn't it? Although I wouldn't go out on a limb and call a market bottom, I certainly think a good portion of the excess has been taken out of the market. That's a healthy sign. Now that people are paying attention to the earnings picture and a lot of the exuberance has been taken out of it, we're in a much healthier position than we had been. We're probably closer to the bottom than the top. Odds are we've seen the worst of it.
That's encouraging! There's a lot to suggest it. The Federal Reserve is in an easing posture, and I think that's a positive factor on the market. Generally, extreme pessimism in the market marks the bottom of a market cycle, but people are much more realistic these days than they were. The fundamentals look pretty bad in certain sectors like technology and telecommunications, but that's being worked out. There's a good chance we'll see a turnaround, especially toward the latter part of the year.
Do you think pessimism on the part of both retail and institutional investors will be necessary before we see a bottom or a recovery? I don't segment institutional versus retail investors. I go with what I see in the market and not necessarily what people say they're doing. The last thing you want to do is to take what someone else is saying as gospel. You have to look at what they're actually doing. Take a look at some of the indicators such as the put-call ratio and some of the volatility measures, for instance. They speak volumes. For example, when there is one put for every call option, it suggests we are close to a market bottom. When there are two calls for every put option, it may indicate that investors are excessively optimistic. You don't necessarily act on that as a single measure, but it does help to take the temperature of the marketplace.
Do you similarly not subscribe to the idea of the two-tiered market, as in the whole world according to technology versus everything else? Technology is the single biggest contributor to the economy and the stock market right now. As technology goes, so go the market and the economy. The technology sector will most likely lead the stock market recovery, and it will also be a leading indicator of the economic recovery.
Very hopeful for the tech bulls out there. That's really the way you have to look at it. Technology is driving economic and stock market performance. So obviously, you have to tune in to what's going on in that sector.
What should investors keep in mind when they're looking at buying stocks? As far as stocks go, the most important aspect is to understand the potential risks and try to get a handle on whether the risk associated with investing in stocks works with what you're trying to accomplish. Any time you're dealing with a select group of stocks, you have the potential for volatility. I worry about that, especially if investors don't understand the need to be diversified. Investors need to understand the concept of diversification. That's so important in getting a handle on risk, especially in today's market environment. You see some of these well-established companies that don't make their projected earnings estimates and take a 20-30% hit in a single day. Single-stock volatility is at extreme levels, and if you're just trying to buy one or two stocks, you must be aware of that.
How about on the mutual fund end? The track record is most important. Investors should study the performance over as long a period as possible. And if it's a new fund, at least make sure it's a well-established fund family. It's important to go with a lot of the well-established players and those fund families that can deliver what they say they can. Not only that, think about the tax efficiency. There's no way of predicting it, but at a minimum, investors should look at the tax-adjusted returns. Recent action by the Securities and Exchange Commission (SEC) and legislation will require mutual funds to display or post tax-adjusted returns as well. Those are two important points.
What do you think we're going to be looking toward in the balance of the year? Good question. Something I read recently pointed out that after three Fed funds rate cuts in a row, the market has always gone up over the following 12 months. There are no guarantees, but looking toward next year, that suggests we will probably have some decent upside potential. It may not be anything like what we saw over the last four years, when we had that big runup and then a sharp slide down, but the long-term average for, say, the Nasdaq 100, is just under 20% if you look at the last 10 years. The long-run average for the S&P is around 12%. I think we'll gravitate closer to those numbers over the next 12 to 18 months.
Let's hope so! Thanks for spending a little time with me today, Mike.
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