Tag Archives: RFN

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.

Where Does Short Ban Leave Short ETFs?

Where does the short-selling ban leave the ETFs that short the financial markets?

ProShares Financial ETFs resumed trading just around noon, after a two-hour halt in the shares of both the Short Financials ProShares (SEF) and UltraShort Financials ProShares (SKF). At 9:33 a.m., the American Stock Exchange halted trading in the UltraShort ETF after it tumbled $22.44, or 19.4%, to $93 and the Short ETF fell $5, or 8%, to $66. Trading in both resumed about 11:40 a.m.

The sharp decline was a direct result of the Security and Exchange Commission’s early Friday ban on the short selling of financial stocks. Short selling is when investors sell shares first in the expectation that they can buy them back later at a lower price. The ban prevents the shorting of 799 financial stocks. CNBC later reported that General Electric and CIT might be added to the list.

The ProShares ETFs give investors the opportunity to short the financial sector in one trade through a long instrument, or as the company says, buying long to go short. The Short ETF gives the inverse return of the Dow Jones U.S. Financials Index and the UltraShort tries to give investors double the negative return on a daily basis.

It appears the halt was caused by ProShares refusal to create new shares. After trading resumed ProShares released a statement saying because of the SEC ban on short selling it did not “expect to accept orders from Authorized Participants to create shares until further notice.” Shares will continue to be redeemed. However, the company added that these shares “may trade at prices that are not in line with their intraday indicative values.”

Ironically, the ProShares ETFs should be a great way for market players to short the financial markets in the wake of the SEC ban, but the halt and the decision, or inability, to issue more creation units throws this into doubt.

ETFs are like mutual funds in that they are both open-end investment companies. They create shares when demand increases and they redeem shares when demand drops. The difference is the mutual fund sells its shares directly to individual investors, but ETFs only sell shares to brokers, dealers and market specialists called Authorized Participants, or APs. The specialist needs to buy all the shares in the index, then trades them with the ETF for an equal number of ETF shares. This is called the “creation unit”. The trade is called the “in-kind trade,” because it’s shares for shares. The AP then sells the ETF shares on the stock market to investors like you and I. If there’s more investor demand for shares of an ETF, the AP will buy the stocks to trade for more ETF shares, then sell the new shares into the secondary market in the hopes of making a profit.

However, ProShares short funds don’t hold the stocks or short the stocks in the indexes they track. They hold futures contracts that short the indexes and swap agreements. Swaps are contracts between two parties, in this case the ETF provider and a counter party, to exchange a revenue stream. According to ProShares May 13 annual report, the UltraShort ETF held swap agreements equally 200% of its net assets.

Bob Pisani on CNBC said early this morning that with the short restrictions it’s harder for the counter parties to satisfy their obligations. “With restrictions on the short side, firms either cannot provide the swaps or the price of providing them has increased dramatically because dealers who sell the swaps hedge by shorting.” Pisani added that there are now fewer counter parties available. He said there were just four.

As of May, those four were Bank of America, Credit Suisse, J.P. Morgan Chase and UBS Warburg and Lehman Brothers. But Lehman went bankrupt on Monday and its demise left ProShares scrambling to find someone to take on those swaps.

So, if the cost of the swaps goes way up, the only way to hedge is to charge far more for the hedge option. This could significantly increase the costs on these funds, which already charge the extremely high expense ratio of 0.95% annually.

IndexUniverse reported an interesting tidbit. It said the Rydex 2X Inverse Select Sector SPDR Financials (RFN) ETF, which also gives a negative 200% return, traded even as the ProShares ETFs were halted. Rydex said its creation/redemption mechanism continued to function normally. IndexUniverse attributed this to RFN using mostly options to gain exposure to the financial market instead of swaps. Historically, swaps have given investors a more efficient way to track the market, but the deleveraging of swaps has been a large component of what is gone wrong with the financial markets this week. And the short-selling ban has only exacerbated that. Meanwhile, the options market continues to function normally.

So, where does that leave the ETFs that short the market? Will they give short sellers the necessary outlet they need to short the markets? Doubtful, because in the end, the funds try to give investors the return of the index. And the index won’t fall much if the component stocks don’t fall much. And the components won’t fall much because, well, they can’t be shorted. However, this shorting ban puts an artifical floor on the financial sector, and the broader market in general.

The first question to ask is can this ban become permanent. Doubtful. There are too many institutional investors that rely on shorting and this essentially removes from them a significant way to hedge their positions. So, if the ban will be removed, what happens when the SEC removes it? Obviously, it’s a big unknown, but if the values are not there and today’s rally is on false pretenses, the shorts could come back and put significant pressure on the market. And when one considers how this came about with no warning and totally screwed all the short sellers, they will be out for revenge. Cold blooded revenge. And you may see the worst market decline since 1929. If that happens. These next two weeks may give investors a nice opportunity to pick up the SEF, SKF and RFN at a low price amid low volatility and just wait for floodgates to open. Geronimo!