I work with a niche fund of funds and hedge fund advisory business. We are always on the outlook for new managers and strategies that provide the edge our clients demand in this difficult environment. Earlier in the year, several managers approached me with complex arbitrage strategies with ETFs.
One stated that the new triple leveraged funds from Direxion will work amazingly well with his rocket science type tactics. After the initial surprise of learning that these products even existed wore off, I decided to look a little deeper into these ultra leveraged ETFs.
If cutting edge fund managers were looking at them, perhaps opportunities exist within these esoteric products for the average trader. Let's take a closer look at these aggressive leveraged animals and see how they can be used to boost your portfolio returns.
Are you new to exchange-traded funds (ETFs)? Be sure to read our ETF primer, ETF Basics: What You Need to Know About Exchange-Traded Funds.
Direxion is the primary firm that offers the tripled leverage ETF products. They have been operating for 11 years and first introduced the so called triple leverage index fund in 2006. However, just in May of this year, they rolled out an entire suite of these products across a wide range of underlying indexes. I stated "so called" due to the fact that these ETFs are leveraged within 50 basis points of the 300X leverage, therefore the common name is a bit of a misnomer.
However, it's a good marketing tool for the products, and they are the highest levered ETFs available to investors. What this means is for every point the underlying instrument/index moves, these products move 2.5 to 3.5 times that amount. For example, if the S&P 500 moves one point up, the ETF moves 2.5 to 3.5% points. As you can imagine this leads to wild gains and losses for traders speculating with these tools. They are becoming very popular among traders with the most traded ones approaching 10 million per day.
The heaviest traded ones include the Direxion Large Cap Bear 3x Shares (BGZ), the Direxion Large Cap Bull 3X Shares (BGU) and the Direxion Financial Bull 3x Shares (FAS). This final one is appropriate ticker name with the first 3 letters of the word FAST! Direxion classifies the ETFs as Bull or Bear. They further break the categories down into Domestic Bull, Domestic Bear, International Bull, International Bear, Commodity, Currency Bull, Currency Bear, Fixed Income Bull, Fixed Income Bear, and finally the basic Money Market fund. There are several funds under each of these categories, except the Money Market fund, of course. As you can see, there is something for almost every trader in this fund family. Not all of the funds are 250 times levered; here is a screen shot of the Direxion page showing the exact funds, their symbols and leverage amount: http://www.direxionfunds.com/products.html.
Why would a trader use these types of products? As you can imagine, the returns have been shocking in both directions this year. One of the bullish domestic index funds is down over 80% this year and, as you can expect, the bearish domestic names are up over 100%. The simplest reason traders would add these products to their portfolio of tools are to magnify gains when speculating in the market. Less capital goes further, more bangs for your buck, so to speak. However, it's critical to ALWAYS keep in mind that this kind of leverage, or any leverage for that matter, is a two edged sword. You can lose just as fast as you can win when trading these volatile products. Several of the other reasons tripled leveraged ETFs make sense include:
- Hedging - Purchasing tripled leverage ETFs inversely correlated to your holdings will allow you to correctly hedge against adverse moves with less capital outlay than hedging with less levered instruments.
- Portable Alpha - This hedge fund sounding strategy is simply adding diversification while maintaining the same exposure. Leverage is utilized to free up capital with the proceeds invested in non correlated investments to decrease volatility. The tripled Levered ETFs are ideal tools for this goal.
- Long Short Relative Value - A great tactic to use to smooth volatility in your portfolio. The concept is similar to pair trading where a long position is taken in the ETF that is believed to be headed up, and a short position placed in an ETF thought to be heading downward. The tripled leverage ETFs allow this strategy with less cash outlay for the same exposure.
As I mentioned, at the start of this article, there are many sophisticated strategies that can be utilized with these tools. Tripled leveraged ETFs can enhance your portfolio but they can easily destroy it, if used in the wrong way. Every trader should look closely at these offerings but do so with caution!
David Goodboy is Vice President of Business Development for a New York City based multi-strategy fund. Read his blog at marketsurfer.com.
