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Here's Where the Dough Really Rises

Call them index funds on steroids. Offered by such companies as Rydex Series Trust, ProFunds Advisors, and Potomac Funds, they promise outsize returns by buying and selling index options and futures rather than just stocks. Last year, these leveraged index products accounted for 2 of the 10 best-performing mutual funds.

Not surprisingly, the top leveraged index funds tracked the NASDAQ 100, comprised of the largest 100 stocks trading over the counter. Dominated by technology stocks such as Microsoft, Intel, and Cisco, the NASDAQ 100 soared 85% last year.

Leveraged funds, most of which are quite small, guarantee serious extra bang for your buck--125%, 150%, even 200% of index returns. The bang comes from derivatives--index options and futures that can be bought with only a small downpayment on a contract's value. A targeted return is achieved by combining options and futures with cash and underlying stocks. You can buy funds based on other indexes or that go short--selling options or futures to bet on an index going down. ''We give investors the most amount of investment exposure [to an index] they can get through mutual funds,'' says ProFunds CEO Michael Sapir. The firm's UltraOTC fund, which seeks to double the return of the NASDAQ 100 index, jumped 185.3% last year, while Potomac OTC Plus rose 104.2%.

Leverage, of course, cuts both ways. Sapir's fund plunged when the market sold off in the third quarter last year. And his OTC short fund was down 67.5% in 1998. ''As exciting as it can be on the upside, it can be equally as bad on the downside,'' says Kevin McDevitt, an analyst with Morningstar Inc.

The first souped-up fund was launched by Rydex of Rockville, Md. The Nova fund--offering 1.5 times the return of the Standard & Poor's 500-stock index--was pitched to sophisticated investors such as fund managers. With large portfolios, they can use the funds as a hedge without wading into options and futures markets themselves. While most funds penalize market timers with redemption fees, Rydex, Potomac, and ProFunds--all based in the Washington area--have none. Investors can market-time to their heart's delight. ''We don't care how much people switch around in our funds,'' says Skip Viragh, Rydex president.

While these funds weren't designed for mom and pop, they are attracting a wider audience. A growing number of individuals, rightly or wrongly, feel sufficiently savvy to handle the huge risks. Rydex' assets under management have swelled from $15 million in 1993 to $3.7 billion last year--including $915 million in the leveraged S&P fund. The Potomac OTC fund grew from $5 million to $80 million last year, while the ProFunds Ultra swelled from $10 million to $264 million.

It makes some analysts uneasy. ''Last year didn't scare enough people,'' says A. Michael Lipper of Lipper Inc. ''These funds will draw more interest until the speculative phase of the bull market is over.''

By Andrew Osterland in Chicago

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Updated Jan. 7, 1999 by bwwebmaster
Copyright 1999, Bloomberg L.P.
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