Have you ever kicked yourself for missing a spike in small-cap stocks? What about last year’s slide in gold? Thankfully, with every missed moment come new opportunities to capitalize.
Direxion was founded in 1997 on the simple premise of giving advisors and investors the right financial tools to profit from market trends. Today, the company has approximately $7.5 billion in assets and offers leveraged index funds, ETFs and alternative-class funds. The products are aimed at investment advisors and sophisticated investors to help them to effectively manage risk and return in bull and bear markets alike.
Daniel D. O’Neill, Direxion’s CEO, spoke to Research about how advisors are using leveraged and inverse ETFs to profit from today’s most important market developments.
In what type of situations are traders using leverage and inverse ETFs?
Most traders that use leveraged ETFs have a bold opinion regarding the direction of the asset class or sector they plan to trade. They use leveraged ETFs to enhance momentum.
Separately, many use the funds to hedge existing positions. For example, right now there’s a concern about a rising interest rate environment. Direxion has a suit of inverse fixed income products that traders use to hedge the negative impact that a rise in rates can have on their bond portfolio.
Traders find leveraged ETFs useful because they provide them with an efficient use of their capital. If a trader is trying to gain $10,000 worth of exposure to an asset class, they can do it by investing $10,000 into a one beta ETF, or $3,333 into a 3x ETF. It’s important to know that the market risk is the same in both cases, but by using a leveraged fund, the trader is afforded the opportunity to invest the remaining capital in other non-correlating assets. This can help them improve their overall portfolio diversification.
In 2009, FINRA issued its “investor alert” about leverage and inverse ETFs. Do you think people are more educated today compared to back then?
We have always believed that the heavy users of leveraged ETFs have had a strong understanding from the beginning of how the products work, and how they should be properly used. Their behavior in the funds (e.g., short holding periods and high share turnover) has always shown this. We have had a strong commitment to education regarding the products to (1) ensure that all that use them, fully understand them and use them properly, and (2) make sure that those that are ill-suited to use the products, understand that they’re not for every investor.
Through our efforts and the efforts of other products providers, and key industry spokesmen and educators, there are certainly more and more investors and traders that have a greater understanding of how leveraged ETFs work. Of course we understand that as more traders become aware of the products, we as an industry have to welcome them into the space with the education they need to determine if these products are suitable for them. We continue to work with intermediaries and supermarket platforms to provide training and education beyond prospectus material, including printed materials, Web content and video.
Despite ongoing economic problems, European stocks have put together two consecutive years (2012 and 2013) of 20%+ gains. Direxion recently launched a pair of 3x daily bull (EURL) and bear (EURZ) funds targeting Europe. Tell us more.
Now that Europe has exited recession and the global economy is recovering, we think this is the ideal time to offer active traders an opportunity to gain leveraged exposure to the most liquid stocks in developed European markets. Some think that Europe is going to continue on a positive path, but there may be fits and starts along the way.
By offering the boldest—300%—exposure to the FTSE Developed Europe Index—in either direction—we’re giving traders the best possible chance of receiving healthy returns and additional diversification, regardless of their investment outlook on the region.
It seems logical the actual name for all leverage and inverse ETFs should contain the amount of leverage (2x or 3x) being used and the target goal (daily). Do you think more uniformity in how these products are labeled is necessary?
We decided very early on that using a straightforward naming format would be in the best interest of all who consider using the funds. Transparency is of the utmost importance with regard to products that can be very volatile in a very short period of time. People who use leveraged ETFs should always be 100% clear about the fact that the funds seek a daily goal, and should always have full knowledge of their leveraged point. There is no better way to ensure this than to put these details in the name of the funds.
While descriptive names are useful, they’re just a start. It’s important for all investors to take on the responsibility to educate themselves about the investments they make. At direxionfunds.com we provide complete explanations, in text and video format, which explain the mechanics and risks of our leveraged ETFs. I would argue that if you understand how to trade options and futures contracts, you should be well suited to learn how to trade leveraged ETFs
From a suitability angle, what are some rules of thumb advisors should keep in mind when using leverage or inverse ETFs for clients?
Well of course, you have to follow your firm’s guidelines regarding the use of leveraged products. Other than that, communication and transparency are key. First, learn about the risks of seeking daily leveraged results. Second, talk to your clients. Understand their risk tolerance and investment objectives. Third, if the first two don’t match, don’t use them. But if you find they’re suitable, these products may help you and your clients manage risk or make profits, no matter what the direction of the market.
Above all, it should be understood that since these products seek a daily goal, they should be monitored very actively. Because the funds reset their market exposure every day, they are not expected to provide 2x or 3x the cumulative return of the benckmark index for periods greater than a day. A general rule of thumb is that when markets are volatile, the funds will typically underperform their multiple of the benchmark’s cumulative return, but during trending markets, they may provide equal to or even greater cumulative returns, as a result of positive compounding.
Although the Direxion Zacks MLP High Income Shares (ZMLP) doesn’t use leverage, it offers an attractive dividend yield compared to bonds. What type of investor might the MLP sector appeal to?
Bonds aren’t considered as much of a “safe haven” as they once were, and in a low-yield environment, income-oriented investors have had an exceedingly difficult time. That’s why we partnered with Zacks Index Services to launch ZMLP.
MLPs are limited partnerships that invest largely in oil and gas infrastructure. They offer steady income, along with certain tax advantages. But they have some tax complexity and liquidity risk. ZMLP is an ETF with a “C-Corp” structure. So it does NOT generate a K-1 tax form like individual MLPs. It can be held in IRAs and 401(k)s, and has the additional benefits of liquidity and transparency that investors demand today. And we’re very happy to have access to Zacks’ proprietary security selection process for identifying the most stable and liquid MLPs to benefit investors in our new ETF.