Rydex Equal-Weights the World

Michael Rawson: Hello. I'm Michael Rawson, ETF analyst with Morningstar. Joining me today is Tony Davidow. Tony is a managing director with Rydex.

Tony, thanks for joining me.

Tony Davidow: Thanks for having us.

Rawson: Following on the success of Rydex S&P 500 Equal Weight, Rydex has launched a series of ETFs based on the equal-weighting concept, both domestically and internationally. Talk about why you're launching these additional funds, and what they may offer an investor which they can't already get in RSP?

Davidow: Thanks. Actually what we do is we actually build on the success of RSP. We launched RSP in 2003. We launched sector, nine sector ETFs in 2006. Then building on that success, we launched additional strategies looking at different geographies and different capitalizations to get the exposure. What we found that was very interesting is we actually capture similar attributes across all of those strategies delivering better performance, better diversification, especially moving away from large concentration bets, and then value-added through the rebalancing that we employ, which actually allows us to sell high and buy low.

Rawson: I'm glad you mentioned those Rydex Equal Weight sector funds, sometimes they get overlooked. I think, when an investor has an idea on a certain sector, but they are not sure which stock to use to play that idea, they might look at the SPDR sector funds for example, but they might not realize they're taking a lot of concentration risk. Could you talk about how those Rydex sector funds might be an advantage in that situation?

Davidow: Thank you, because we're excited about our sector strategies, and I do think they're great tools for advisors as they think about building model portfolios. You're 100% right that by reducing the concentration risk, i.e., you could have one or two names provide a disproportionate impact on the portfolio returns, equal weighting those sectors has actually delivered very favorable risk-adjusted results over time. They are great strategies, they're great building blocks for advisors, and we want to make sure they're aware of those.

Rawson: Now the emerging markets have been a hot area; certainly in 2010, we saw a lot of monies flowing into ETFs that follow the emerging markets. Rydex is launching emerging market in international Equal Weight products. Could you tell me how they're going to differentiate from the existing products that are out there?

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Davidow: Absolutely. And emerging market is a very exciting area. We love our emerging markets strategy, because what's interesting is, we equal weight the companies and what you're really getting is you're actually getting very pure exposure from what's happening within each one of those exciting regions that we're trying to invest in.

What's interesting is, as we look at the performance of Equal Weight versus Cap Weighted besides delivering the favorable risk-adjusted results that we've seen across all of our strategies, we actually believe we're getting pure exposure of what's happening in those economies and those parts of the world. The cap-weighted tended to be dominated by some of the multinational names. So, actually you don't get as much emerging market exposure, and you tend to get exposure that looks more like more developed and larger names in the portfolio.

So, emerging market to us is very, very exciting. We've actually looked at the emerging market results relative to the cap weighted equivalents and relative to all the active managers in the space, and we're very pleased with how well it stacks up, not only delivering superior results, but also superior risk adjusted results.

Rawson: Now ETFs demand liquidity in the underlying securities that they invest in. Conceptually, with the market cap weighted fund, when it comes time to rebalance as a stock has appreciated in value, its new weight doesn't need to be adjusted because the market cap weighted fund has participated in that appreciation. With equal weighting, there is the theory that that might cause more turnover or more transaction costs. Has Rydex investigated this and what have you found?

Davidow: Yes, we have, and you're right that because of the rebalancing the turnover will be a little bit higher. But we've actually spent a lot of time looking at it, and our conclusion is, we're more than compensated by the excess return for the slightly higher turnover and the slightly higher transaction cost.

Rawson: And actually with your products that are out there now RSP, the Rydex S&P 500 Equal Weight, we've looked into it ourselves and the turnover and transaction costs have been less than we would have expected I think particularly because on any given quarter you are not going to have all of the stocks drastically changing the weight. It's just a few at the end, so you're not causing an unnecessary amount of turnover.

Now, Rydex is one of the early providers of ETFs, one of the early adopters of bringing that product to the marketplace. Can you talk about Rydex's plans for the future. Obviously you're launching a bunch of products right now. What do you see in the future in terms of Equal Weight or other strategies?

Davidow: And I would say that, yes, we're very early. Our RSP strategy was launched in 2003, the sectors in 2006. We've got Pure Style ETFs. We have just added to our Equal Weight family, and we actually have a registration statement that allows us to offer an additional 13.

So we are very committed to the business. I think to be more succinct on that, we will try to offer strategies that we think make sense, that we think exhibit the same sort of characteristics that we've experienced over time, and we're trying to identify are there areas of the market that really need different types of exposure. They may be in the Equal Weighted family or they may be in another way of getting that exposure, but we're absolutely committed to the business. We are investing heavily to be a big player in the market. Our ETF business today is about a $7.5 billion business. We'd look to grow that pretty dramatically over time.

Rawson: Tony, when people talk about ETFs, they often go back to their old active versus passive debate. Where does Rydex stand on the concept of active versus passive investing?

Davidow: Well, we are a believer in active and passive. We don't think it has to be one or the other. We're certainly a believer, there is active alpha to be found in the marketplace and when you can get that alpha, that's great. We are also a believer that beta or getting passive exposure is an important part of a portfolio. We are just not believers that you want to pay alpha fees and get beta results.

Rawson: Great. Tony, well, thanks for joining me today.

Davidow: Well, thanks for having me.

Rawson: I am Mike Rawson with Morningstar.