Rydex to be Part of Guggenheim by Year End

Last night at the Seeking Alpha cocktail party in Tribeca, I spoke with some staff members at Guggenheim Funds. First reported on this blog in December, it appears that Guggenheim Partners, the parent company, is still involved in talks to combine the former Claymore Funds, renamed Guggenheim Funds, with Rydex, another ETF company it bought last year. The staffers say Rydex should be made part of Guggenheim funds by the end of the year.

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Will Rydex Brand Disappear?

Rumors are floating around that Guggenheim Partners is in serious discussions about merging the Rydex ETF family with the Claymore ETF family under the brandname of Guggenheim Funds.

On December 23, I was scheduled to have a lunch meeting with Steve Baffico, who oversees the retail business including distribution, strategy, marketing, investment product development, and strategic initiatives for Guggenheim Funds, which is the new name for the ETF firm formerly known as Claymore Securities.

After cancelling a lunch in mid December, we had rescheduled for the day before the Christmas Eve. The PR guy confirmed the reservation the afternoon before. Around 11 am, the PR guy cancelled the lunch and said Baffico had been called into a last minute, emergency, all-day meeting.

Now really, what kind of company calls a last minute, all-day meeting the day before Christmas break? Pretty suspicious. I made a few calls and sources said Guggenheim Partners was holding a meeting to discuss merging the Rydex and Claymore families into one. Made a few more calls and found out Rydex had held a similar meeting earlier in the week.

No one is willing to go on the record to confirm the merger story, but expect to hear news of the merger in January.

Flying High with Airline Stocks

The skies have been unusually friendly of late for investors in the fickle airline industry. Over the past year through October 28, the NYSE Arca Global Airline Index surged 83.9%, walloping Standard & Poor’s 500-stock index by 68 percentage points. The Guggenhiem Airline ETF (FAA), which tracks the airline index, leapt 79.7%, giving it a tracking error of 420 basis points, or 4.2 percentage points.

Can the sector keep it up? Don’t bet on it.

One big reason for the airlines’ big move is that they are classic cyclical stocks. When the economy takes a dive, travel is one of the first expenses cut by both businesses and vacationers. As the economy picks up, airline profits rebound robustly as businesses reinstate travel budgets and start filling planes with passengers paying full freight, as opposed to leisure travelers who buy the cheapest tickets they can find. The International Air Transport Association, a trade group, recently boosted its estimate for the industry’s 2010 profit, from $2.5 billion to $8.9 billion. The industry lost $9.9 billion last year, according to IATA.

For the full story go to Kiplinger.com.

How Guggenheim Partners Became a Player

With its purchase of Rydex SGI in February, a little-known asset manager by the name of Guggenheim Partners suddenly became the seventh-largest ETF provider in the U.S. Prior to its purchase of Claymore Securities just seven months earlier, Guggenheim had only been involved in one product for retail investors. The truly shocking part is the whole thing might have been an accident.

On Feb. 16, Guggenheim bought Security Benefit Corp., a struggling financial services firm out of Topeka, Kan., for an undisclosed sum. In the package, Guggenheim received four businesses: Security Financial Resources, a national provider of retirement plan services for more than 135,000 accounts, primarily in the education market; Security Benefit Life, a provider of fixed and variable annuities to 200,000 policyholders; se2, the administrator of more than 700,000 policies and $30 billion in assets for the insurance and financial services industry; and SGI Security Global Investors and Rydex SGI, an asset manager and ETF provider.

Right after the deal went down, Todd Boehly, Guggenheim’s managing partner in the office of the chief executive, told Investment News that purchasing Rydex SGI for its ETFs “wasn’t the primary consideration behind the acquisition of its parent company” but that it “presented to us an attractive opportunity.”

Yet, suddenly they’re a major player and the owner of two of the most innovative houses in the ETF industry.

Rydex SGI entered the ETF market in 2003 by launching the first ETF to use an alternative weighting methodology, the Rydex S&P Equal Weight ETF (NYSE Arca: RSP). Known for creating the inverse mutual funds, Rydex is also one of only three firms that offer leveraged and inverse ETFs. In addition, it created the first family of exchange-traded products to track individual currencies: The CurrencyShares currently give investors access to nine major currencies without the hassle of entering the actual foreign exchange market.

Meanwhile, Claymore has made a reputation for being the first in many high-concept thematic and tactical portfolios, such as the water industry with the Claymore S&P Global Water Index Fund (NYSE Arca: CGW); the popular emerging markets bloc known as BRIC (Brazil, Russia, India and China) with the Claymore/BNY Mellon BRIC ETF (NYSE Arca: EEB); and the solar power industry with the Claymore/MAC Global Solar Energy Index ETF (NYSE Arca: TAN).

At the end of February, Rydex SGI had about $22 billion in assets under management. Its 31 ETFs held $5.8 billion, making it the ninth-largest ETF sponsor in terms of assets, according to the National Stock Exchange. Together with the $2.74 billion in the 32 ETFs held by 13th-place Claymore, the combined ETF assets jump to $8.54 billion, leaping over BNY Mellon and WisdomTree to be the seventh-largest ETF firm behind iShares, State Street, Vanguard, Invesco PowerShares, ProShares and Van Eck. Claymore held $15.2 billion across all its product lines, which include closed-end funds and unit investment trusts, at the end of 2009.

What’s The Plan?

Considering Guggenheim now owns two of the most unique ETF houses, ETFR wondered about the firm’s strategy. How do ETFs fit into its overall business plan? Would the firm keep the Rydex and Claymore brands separate or merge them? And are there plans to buy more ETF providers? Guggenheim Partners declined requests for comment. Considering the fortuitous nature of the Rydex purchase, it may be that its strategy is still under development. But some in the ETF industry see interesting potential in the new firm.

“I think it’s an interesting combination buying both Rydex and Claymore. They both have different offerings in the ETF lineup,” said Reginald Browne, managing director of listed derivatives group at Knight Equity Markets. “Once Guggenheim determines its core strategy in the ETF space, combining the two entities I believe will be an interesting competitive advantage given their diverse lineup, and a compelling offering among ETF sponsors.”

In previous reports, Boehly said there are no plans to integrate Claymore and Rydex SGI, but “longer term, we’ll be looking at a lot of things related to how to optimize business” and that Rydex plans to launch “a lineup of new innovative products” within the next six to nine months.

“As promising as it looks, this is basically a low-margin business for a high-margin house,” said Ron DeLegge, editor and publisher of ETFguide.com, a San Diego-based Web site focused on ETFs. “I wouldn’t be surprised if they consolidated funds, getting rid of the ones with few assets and trying to gather assets and trading volume from a few strong funds.”

Well, a first look at the new line came with the recent launch by Claymore of a suite of ETFs designed to track broad market indexes, the Wilshire 5000 Total Market ETF (NYSE Arca: WFVK), the Wilshire 4500 Completion ETF (NYSE Arca: WXSP) and the Wilshire U.S. REIT ETF (NYSE Arca: WREI).

This was originally published in Exchange-Traded Funds Report. For the full story click here.

Goldman Talks About Rydex Closing 12 Funds

Rydex|SGI announced last Friday that it will close 12 of its 14 leveraged and inverse ETFs. Inverse ETFs essentially short an index and try to earn the negative return of the index it tracks. Leveraged ETFs seek to provide 200% or 300% of an index’s daily return or negative return.

“The premium reason is they hadn’t garnered a significant amount of investor interest,” said Richard Goldman, the chief executive officer of Rydex|SGI, in an interview with ETFsForTheLongRun. “It was a small percentage of the ETF assets under management.”

Including the affected funds, the Rockville, Md., firm offers a lineup of 40 exchange traded products (ETPs). The 12 funds held approximately $129 million in assets, or less than 2% of Rydex|SGI’s total $7 billion in ETF assets under management. Typically, an ETF needs $50 million in assets to remain viable. The ETP division represents 29% of Rydex’s total $24 billion under management. Closing these funds will allow Rydex to focus resources on the products with the most demand.

The consolidation is a bit of an ego bruise for Rydex as it invented the leveraged and inverse mutual fund. Even though Rydex was an early entrant in the ETF market, launching its first fund in 2003, Goldman acknowledged it had lost the first mover advantage on the inverse and leveraged funds. Because ETFs are sold on the stock exchange and not through financial advisors like mutual funds, there’s little need for replicating another fund’s strategy. Thus the first fund to track a market typically garners the most name recognition and hence, assets. ProShares, the market leader, launched its first inverse and leveraged ETFs in 2006. Direxion is the other main player in this space.

“I won’t say universally we’re getting out of the leveraged and inverse business,” said Goldman. “We leaving options open and won’t constrain ourselves to not participate in that space. The overall leveraged ETF business is still strong and there’s not a lot of degredation in the asset base.”

Goldman said that Rydex’s recent purchase by Guggenheim Partners had nothing to do with the closing of the funds, or problems at the firm. He said almost all the Rydex products had strong positive net inflows in 2009 and that total ETP assets grew about 30%. Rydex mutual funds also saw net cash inflows for the year, with tremendous growth in alternative investment strategies packaged as mutual funds, fundamental alpha strategies and fixed income formats.

The CEO added that he doesn’t believe Guggenheim has plans to merge Rydex with Claymore, the ETF firm Guggenheim bought last year. “We’re committed to growing our franchise and it’s an important growing piece of the business.”

Friday, May 21, will be the last day of trading on NYSE Arca for the following 12 funds.

Rydex 2x Russell 2000 ETF (RRY)
Rydex 2x S&P MidCap 400 ETF (RMM)
Rydex Inverse 2x Russell 2000 ETF (RRZ)
Rydex Inverse 2x S&P MidCap 400 ETF (RMS)
Rydex 2x S&P Select Sector Energy ETF (REA)
Rydex 2x S&P Select Sector Financial ETF (RFL)
Rydex 2x S&P Select Sector Health Care ETF (RHM)
Rydex 2x S&P Select Sector Technology ETF (RTG)
Rydex Inverse 2x Select Sector Energy ETF (REC)
Rydex Inverse 2x Select Sector Financial ETF (RFN)
Rydex Inverse 2x Select Sector Health Care ETF (RHO)
Rydex Inverse 2x Select Sector Technology ETF (RTW)

Between the close of trading on May 21, and May 28, the affected funds will liquidate their portfolio assets. Shares still held on May 28 will be redeemed automatically. Investors will receive a cash distribution equal to the net asset value of their shares as of the close of trading May 28. This amount includes any accrued capital gains and dividends, minus the costs to close the fund.

New ETF to Hold Closed-End Shares

Invesco PowerShares launched the first ETF whose portfolio consists of closed-end funds last month. The PowerShares CEF Income Composite Portfolio (PCEF) tracks the S-Network Composite Closed-End Fund Index.

Like mutual funds and ETFs, closed-end funds are diversified portfolios, but they differ in the way they sell and price their shares. Mutual funds and ETFs are open-end funds because they can sell as many shares needed to satisfy investor demand. In addition, they’re priced each night at their net asset value, or NAV. However, a closed-end fund sells a limited number of shares on the stock exchange in an initial public offering. Because closed-end fund shares trade on the stock exchange, demand for the shares determines price not the NAV. Thus, most closed-end funds sell at a discount or premium to the fund’s NAV.

PCEF is a “fund of funds,” as it invests its assets in the common shares of funds included in the underlying index. The index selects constituents from a universe of 350 U.S. closed-end funds with a concentration in one of three sectors: taxable fixed income, which includes corporate bonds, government bonds and mortgage back securities; high-yield emerging market debt and bank loans, and option-income funds. Unique to close-end funds, option-income funds buy high dividend yield equities and sell options to create high current income.

The fund of funds concept is an interesting one. Essentially, the fund sponsor says there are a lot of great funds out there and we’re going to give you one-stop shopping and create a portfolio of the best so you don’t have to do the research. Since the cost of buying many closed-end funds would be huge, you get the ETF benefit of diversification within a minimal investment. But since, each closed-end fund is already a diversified portfolio, how many does one investor really need?

The key advantage to this kind of ETF is dividend yield, which can get pretty sizeable with closed-end funds.

“PowerShares wanted high maximum current yield and to be well diversified,” says Paul Mazzilli, senior advisor to S-Networks Global Indices. “Because ETFs invest in the most liquid high-yield bonds, they don’t have the highest yield, but do have significant tracking error. Since, closed-end funds can hold illiquid securities, high-yield closed-end funds will have a higher yield than high-yield ETFs.”

Dividends and yield have become hot topics as people look for some guaranteed returns in a market full of uncertainty. Yield is the rate of return you receive from the dividend. While the dollar amount of the dividend payment remains the same, yield moves daily in an inverse relationship to price. When the share price of a closed-end fund falls, the yield percentage rises. When prices rise, yield falls. Currently, the index has a composite yield of 8.66%, which is double the 10-year Treasury note.

Up to now investors have had only one choice it they wanted to track closed-end funds in an exchange-traded product. Two years ago, the Claymore CEF GS Connect ETN (GCE) launched. Unlike PCEF, which actually holds closed-end funds, GCE is an exchange-traded note, an unsecured subordinated debt instrument that promises to pay the index’s return without actually holding assets. The GCE currently yields 8.3%, but since it has not funds, it receives no dividend, so their are no payouts. The yield is merely factored into the total return of the index. With only $3 million in assets under management, it hasn’t garnered much enthusiasm.

One especially nice thing about PCEF is that dividends are paid out monthly. This ETF expects to go ex-dividend on March 15, which means you need to buy before then to get this month’s payout.

Currently, the index holds 71 closed-end funds, of which 27 invest primarily in taxable investment-grade fixed-income securities, 15 invest primarily in high-yield fixed-income securities and 29 primarily use an equity option writing (selling) strategy. The index bases its weightings on a value-based rules approach, instead of market-capitalization. Market-cap weightings give additional weight to richly valued funds and underweight the undervalued funds, which is the opposite of what an investor wants.

“During the quarterly index rebalancing, we look at the average discount of all the funds,” says Mazzilli. “The funds with a wider discount get their weighting increased, while the funds with as wider premium get their weight decreased. Like fundamental indexing, the index focuses on value, selling the expensive funds and buying the cheaper funds.”

This approach enhances the fund’s return because it’s focused on securing the highest yield over price appreciation. It addition, you avoid capital gains inside the fund because closed-end funds and ETF’s have more tax efficient structures than mutual funds.

However, there are some serious negatives here. High yields are not just a function of shares being discounted, but typically signify a higher level of risk in the underlying securities, especially high-yield emerging market debt. The multiple layers of diversification within the closed-end funds and the ETF itself should lower that risk. However, closed-end funds have the transparency requirements of mutual funds. They only need to tell you what they own every six months. So, you never really know the level of risk of each fund’s holdings.

Then there’s the cost. While PCEF charges an expense ratio of 0.5%, a reasonable rate, each closed-end fund in the ETF also charges an expense ratio which will be paid out of the underlying funds. And while the ETF won’t hold any funds with an expense ratio higher than 2%, this duplicate level of fees significantly increases the cost of the investment and it’s not specified by how much, but it looks like 1.8%.

Dave Nadig of IndexUniverse calls it “the worst of all possible worlds – zero transparency, high costs, and unreliable pricing.” I’m not sure I would go that far, but I am concerned by the fact that PowerShares hasn’t posted a factsheet yet on the fund.

In the comments section, Mazzilli debates Nadig over the funds transparency, pointing to the white paper detailing the fund’s workings. In addition, on the S-Network Web site you can find the constituent list for the index as of Dec. 31, 2009, which would have been the holdings when the fund launched. You can also find the fund holdings on the PowerShares Web site. You could make the effort to find out what the closed-end funds hold, but that’s a layer of research the ETF tries to help you avoid.

Personally, I like the idea of a high-yielding investment that pays monthly. But I’ve always been bothered by the duplicate level of fees found in every fund of funds product and how it will take a significant bite out of that dividend payment. The big benefit seems to be the ability to invest in closed-end funds with a much lower level of risk than you would have when you put a lot of money in a single fund.

Schwab Ready to Enter ETF Market

Mutual fund giant Charles Schwab Investment Management expects to launch its first ETFs during the first week of Novemeber.

A subsidiary of The Charles Schwab Corp., the investment management unit is one of the nation’s largest asset management companies. It held more than $210 billion in assets under management as of September 30. The firm, which says it’s the third-largest provider of retail index funds, manages a total of 82 mutual funds, with 36 actively-managed.

Claymore Cashes Out

It looks like the rumors were true.

For about year, rumors swirled around that ETF firm Claymore Securities had put itself up for sale. Well, it finally found a buyer. Guggenheim Partner, a privately held institutional money manager, on Friday agreed to acquire the entire Claymore Group. The Lisle, Ill., company includes the ETF firm Claymore Securities, as well as Claymore Advisors and Claymore Investments in Canada. All will become wholly owned subsidiaries of Guggenheim Partners. Terms of the transaction were not disclosed. The deal is expected to close at the end of the third quarter.

The deal gives Guggenheim, an institutional financial services firm with more than $100 billion in assets, its first retail operation. According to the National Stock Exchange, as of June 30, Claymore was the 13th-largest U.S. ETF provider, with 35 ETFs and more than $1.6 billion in assets under management. With more than $740 million in assets, its largest fund is the Claymore/BNY BRIC ETF (EEB)

In 2001 Claymore began as a creator of unit investment trusts (UITs) and closed-end funds. It began selling ETFs in 2006. At the end of the second quarter, all the Claymore entities combined managed $12.9 billion in assets, with more than $2 billion in Canada.

For more than a year, rumors have abounded that Dave Hooten, the Claymore Group chairman and chief executive, was looking to cash out of the firm he created, in a fashion similar to his old friend and ETF rival, Bruce Bond, the founder of PowerShares. In 2006, mutual fund giant Invesco bought PowerShares for $100 million and the possibility of contingency payments.

Claymore created some of the most original ETFs in the industry, such as the Claymore/KLD Sudan Free Large-Cap Core, the Claymore/Clear Global Vaccine Index and the Claymore/NYSE Arca Airline ETF (FAA). But many funds had a hard time acquiring assets because of their niche appeal. Claymore became the first ETF firm to close funds when it shut the Sudan and Vaccine funds along with nine others in February 2008.

Most ETFs are index funds. And Claymore has struggled because of the indexes its funds track. Unable to link up with a major index provider and working in an industry that makes it difficult for two funds to track the same index, Claymore’s basic large-cap, small-cap, value and growth funds failed to attract a huge audience. Claymore’s biggest index providers are Zacks and BNY/Mellon Bank.

While the Claymore deal comes on the heels of Blackrock’s purchase of iShares, Barclays ETF company, the trend isn’t obvious. Barclays, a giant British bank, was forced to sell its market-leading ETF firm, a huge moneymaker, in order to avoid a British government takeover due to depleted cash reserves from the financial crisis. While Claymore didn’t give a reason, a few come to mind.

1) The current market environment has hurt all fund companies. Over the past year, many investors pulled out cash and remain fearful of putting money back in the market.

2) The ETF business has been a struggle for all small independent firms. Unable to latch onto a major index provider, all the independent firms, like Claymore, have needed to create niche products. And while some have been great ideas, they nonetheless have had to work harder to attract attention to these less than obvious portfolio ideas. In a market full of fear, investors don’t want to invest in offbeat ideas. They tend to gravitate to conservative and well-known indexes. Many small ETF firms have gone out of business over the past two years.

3) In light of the combination of the above reasons, I think the upper management of Claymore wanted to cash out while their firm still had a good reputation and a sizeable amount of assets.

What this all means for investors remains unclear.