Check out this week’s Danger Zone Interview with Chuck Jaffe of Money Life and MarketWatch.com.

Rydex Funds are in the Danger Zone this week. This fund series, owned by Guggenheim Investments, offers investors poor stock picking and high fees. Rydex’s funds consistently rate at or near the bottom of all sectors and styles.

Bottom of the Class

In our 2Q14 Best and Worst ETFs and Mutual Funds series, a Rydex mutual fund earned the worst ranking in 7 out of 10 sectors. This should not be surprising, as 28 out of the 78 funds it offers (36%) earn our Very Dangerous rating. Only the bottom 10% of funds get our Very Dangerous rating, so Rydex Funds has nearly four times the normal amount of funds with a Very Dangerous rating.

We rank the top 10% of funds as Very Attractive and the next 20% as Attractive. Only 2 out of 78 Rydex Funds (3%) earn our Very Attractive rating and the same number earn our Attractive rating.

Figures 1 and 2 show the breakdown of our ratings for all the ETFs and mutual funds we cover compared to our ratings for just Rydex funds. They show just how much Rydex funds skew towards the Dangerous and Very Dangerous side.

Figure 1: Rating Landscape For All ETFs and Mutual Funds vs. Rydex

Rydex_RatingsSources:  New Constructs, LLC and company filings

Over 90% of investor Assets in Rydex Funds are allocated to funds with Neutral-or-worse ratings. Only 9% of Rydex investors are getting funds that rank in the top 30%. Note that our ratings are forward looking and based on costs and holdings, not past performance.

Drastically Higher Costs

The bloated fees of Rydex Funds help to explain a part of their poor rankings. These funds are far more expensive on average than the rest of the fund universe. The average total annual cost (TAC) for Rydex Funds is 3.70% while for all sector funds the average TAC is 2.40% and for all style funds the average TAC is 2.02%.

13 out of 78 (17%) of Rydex Funds charge total annual costs of 5% or more. 17% is quite high compared to the rest of the fund universe where less than 1% (only 68 out of 6859) of mutual funds charge total annual costs above 5%. Even though Rydex Funds account for only 1% of all the mutual funds we cover, they account for almost 20% of the funds that charge investors more than 5% a year in fees.

Unsurprisingly, all 13 funds that charge above 5% a year earn our Very Dangerous rating. A fund’s holdings (i.e. expected performance) have to be extraordinarily good to overcome such a significant handicap. However, high costs alone can’t explain all the issues with Rydex Funds. After all, there are still 15 funds that earn our Very Dangerous rating but charge less than 5%, including some, like Rydex Series Funds: Biotechnology Fund (RYOIX) that charge below average total annual costs.

Poor Holdings Too

In addition to higher costs, Rydex Funds have poor holdings. Poor holdings are worse than high costs, as holdings are the ultimate driver of performance. No matter how low the fees, a fund’s performance will be poor if its stock picking, or portfolio management, is poor.

Rydex Series Funds: Russell 2000 Fund (RYRHX) is a good example of a fund with reasonable total annual costs (2.02%) but poor holdings. Only 4% of RYRHX’s assets are allocated to Attractive or Very Attractive stocks, while 47% of its assets are allocated to Dangerous or Very Dangerous stocks. What’s worse, 25% of the fund’s assets are currently in cash. If investors want to hold cash, they can put it in the bank and earn interest on it. They shouldn’t be paying a fund money to hold cash for them.

One of my least favorite holdings in RYRHX is also its largest holding, athenahealth Inc (ATHN). David Einhorn recently made a short case for ATHN at the Ira Sohn conference, and our research backs up his thesis. ATHN may be growing revenues rapidly, but its profitability is in decline. Its return on invested capital (ROIC) has declined from 23% in 2008 down to just 2% in 2013. Despite this declining profitability, ATHN is priced for tremendous profit growth. In order to justify its current valuation of ~$115/share, ATHN would need to grow after-tax profit (NOPAT) by 38% compounded annually for 13 years. Such a high valuation prices out any potential upside while leaving significant risk for investors.

A large allocation to ATHN helps to explain why RYRHX earns a Very Dangerous rating despite its reasonable costs.

Best and Worst Rydex Funds

The worst rated Rydex Fund is a close cousin to RYRHX. Rydex Dynamic Funds: Russell 2000 2x Strategy Fund (RYRUX) is the worst rated Rydex Fund and ranks 6,848 out of the 6,859 mutual funds we cover. RYRUX has the same holdings as RYRHX; only it’s leveraged to double the performance of its index. Leverage means extra large exposure to Dangerous stocks like ATHN as well as significantly higher costs. RYRUX charges investors total annual costs of 8.66%, which includes 4.75% in transaction costs.

Even the best Rydex mutual fund falls short of its ETF counterpart. Rydex Series Funds: Consumer Products Fund (RYCIX) earns our Very Attractive rating, but we still recommend investors buy its ETF benchmark, Consumer Staples Select Sector SPDR (XLP) instead. XLP allocates over 41% of its assets to Attractive-or-better rated stocks compared to just 29% for RYCIX. RYCIX has below average total annual costs of 1.99%, but it is still significantly more expensive than XLP at 0.18%.

At best, Rydex offers a more expensive, lower quality portfolio than what investors can get from other ETFs or mutual funds. At worst, Rydex poses significant risk of diminishing investors’ wealth. We ask: why take that risk when there are plenty of better alternatives.

Sam McBride contributed to this report.

Disclosure: David Trainer and Sam McBride receive no compensation to write about any specific stock, sector, or theme.

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