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A Look at Rydex Fund Assets


Aww, now you're just makin' excuses.


Over the past few years, I've written about indicators that have fallen off in their effectiveness due to changing market dynamics. As innovations come to market (listed options, futures, ETFs) and market participants change priorities, formerly reliable data becomes less.
One of the benefits of these innovations is that new measurements become available to measure the risk appetite of investors. I'll touch on several of these as we go along, but the focus today is one that has actually been around for several years. Even so, it has changed over the years and we need to change with it.

Today's focus is the Rydex mutual fund family.


Rydex is a mutual fund company, no different than the household names like Vanguard and Fidelity. However, Rydex has been more progressive in their offerings to the public, being one of the first families to allow investors to bet against rising stock prices, and also offer funds on somewhat esoteric sectors like Real Estate and the U.S. Dollar.

Rydex also offers leveraged funds. In the Velocity fund, for example, your investment is leveraged 2-to-1 to the value of the Nasdaq 100 index. If the Nasdaq 100 rises 1% on a given day, then your investment in the Velocity fund should rise by around 2% (of course, it works both ways and you can lose money quickly should the market decline).
One other progressive move on Rydex's part, and something that I consider a stroke of marketing genius, is that they release the asset levels in each of their funds to the public each day. This allows anyone interested to get near real-time feedback on where investors are concentrating their funds.


While many professional traders use the Rydex funds for managing client money, the funds are quite popular with individual investors who use the funds to speculate or hedge in retirement accounts, which otherwise would be closed off to leveraged or short-side bets.
Regardless of who might be trading the funds, the fact of the matter is that these investors suffer from group-think like most other mass-market products we follow. They tend to get their most bullish after an extended market rise, and most bearish after a substantial fall. Not surprisingly, the market tends to reverse its moves after these extremes, thus solidifying the Rydex data as a contrary indicator.

The data is also useful because there is no real lag – we see today's asset moves today, not tomorrow or next week or next month. Another nice quality is that the funds are popular enough to attract a good sample of traders, but not so popular that the asset bases are so large as to make day-to-day movements negligible.


Like any other fund family, Rydex makes money by charging fees to their investors. So the more assets under management, the more money they can make. Like any other business, Rydex does what it can to grow its asset base, and because of that there are trends in the data that have less to do with investor sentiment than they do advertising efforts by the company.

Rydex asset analysis has also grown more popular among analysts – much more popular. Because of its use as an indicator, and the unique properties of the funds, we have seen the behavior of the traders change over time.

For example, in the past when the S&P or NDX enjoyed a large gain on a given day, we'd nearly always see assets in the leveraged long funds jump higher to try to ride more of an up move. Now what we see is often the opposite – when the markets make a large move, assets go into the opposite funds. More and more Rydex traders are using the funds as a contrarian bet as opposed to a trend-following one.

Because of those changes, it has become more of a challenge to interpret the broad-market S&P 500 and Nasdaq 100 fund assets.



The chart above shows a weighted bull and bear ratio using the S&P 500 and Nasdaq 100 Rydex asset data. The long-side fund assets are combined and weighted according to their leverage, as are the bearish funds.

The challenging part is that the indicators can now be interpreted two different ways – as a pure contrarian gauge, and as a divergence tool.

For example, the highest point for the bull ratio was in late 2004. Investors were all bulled up as the S&P was making new recovery highs, but those bets didn't pan out so well, at least not for a while. On the other hand, the bear ratio was actually higher than the bull ratio last October, a sign of extreme pessimism, and the markets of course rallied from there.

On the other hand, we can also see some use in the divergences between price and asset levels. In March 2005 the S&P made a new high, but we see that these investors had pulled in their willingness to chase prices higher. The bull ratio did not come close to making a new high along with price, and the markets struggled going forward.

We're seeing a similar pattern now. Like the Investor's Intelligence Survey that I went over last week, we're seeing indications that some traders are reducing their risk tolerance despite the broad market indexes being close to their highs. Bulls like to point out that this is the "wall of worry" that bull markets are supposed to climb, but if traders don't increase their risk tolerance, prices will fail to hold.
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No positions in stocks mentioned.

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