Tag Archives: seeking-alpha

Direxion To Close Down 3 Leveraged ETFs

The Direxion Shares ETF Trust has decided to cease trading three of its leveraged products after the closing session on October 20, 2015. The decision, based on the recommendation of the funds’ sponsor Rafferty Asset Management, LLC, was taken due to the funds’ inability to attract sufficient investment assets. We believe strong competition in the asset class and pitfalls of investing in leveraged ETFs in this turbulent time with high volatility might have kept investors away from these funds. Leveraged ETFs are designed to magnify returns of the underlying index. However, these products lose their asset value during a highly volatile market environment, particularly in the long term. Further, their performances could vary significantly from the actual performance of their underlying index over a longer period when compared to a shorter period (such as, weeks or months) (read: Understanding Leveraged ETFs ). Let’s discuss the three products, serving divergent interests, which are about to be closed down (see all Leveraged Equity ETFs here). Direxion Daily 7-10 Year Treasury Bull 2X Shares ETF (NYSEARCA: SYTL ) SYTL tracks the NYSE 7-10 Year Treasury Bond Index, which is a multiple-security fixed income index that aims to track the total returns of the intermediate 7 to 10 year maturity range of the U.S. Treasury bond market. This product provides two times (2x) exposure to the daily performance of the underlying index. The fund has been overlooked by investors as it has garnered only $4.5 million in assets since its inception in July last year. It charges 60 bps in annual fees from investors. However, the product gained 3.8% so far this year. The closure of this ETF seems unfortunate at a time when investors are flocking toward bond ETFs due to global stock market instability and Fed’s reluctance to raise interest rates in the near term, as lower rates push the yields down, boosting the prices for the bonds. Investors still interested to play the leveraged Treasury bond ETF category could consider the more popular ProShares Ultra 7-10 Year Treasury ETF (NYSEARCA: UST ) , which provides two times exposure to the Barclays Capital U.S. 7-10 Year Treasury Index. This product has roughly $95 million in AUM and charges 95 bps in fees. The fund returned 4.8% in the year-to-date timeframe. Direxion Daily Mid Cap Bull 2X Shares ETF (NYSEARCA: MDLL ) MDLL follows the S&P Mid Cap 400 Index, measuring the performance of the mid-cap segment of the U.S. equity universe. It seeks daily investment results of 200% of the performance of the benchmark index. The fund is almost neglected gathering a meager $1.5 million in assets since its inception in July last year. It charges 60 bps in fees from investors and was down 15.7% in the year-to-date period. The closure of this fund doesn’t look good either at a time when mid-cap funds are favored by investors due to their potential to move higher in difficult times, especially if political issues or financial instability creep into the picture. Investors still interested in leveraged mid-cap ETFs could consider the Direxion Daily Mid Cap Bull 3x Shares ETF (NYSEARCA: MIDU ) by the same issuer. The fund seeks investment results of 300% of the price performance of the S&P Mid Cap 400 Index. It has $54 million in AUM and charges 95 bps in fees. The fund lost 5.9% so far this year. Direxion Daily Basic Materials Bull 3X Shares ETF (NYSEARCA: MATL ) MATL tracks the Materials Select Sector Index, which includes companies from the chemicals, metals & mining, paper & forest products, containers & packaging, and construction materials industries. It provides three times (3x) exposure to the daily performance of the underlying index. The fund was hardly noticed by investors as it has accumulated only $2.2 million in assets since its launch in June 2011. It charges 95 bps in annual fees from investors. The basic materials sector has been dragged down by weak agricultural fundamentals, sluggish demand in energy markets and persistent slowdown in China – the world’s second largest consumer of raw materials. This might have made the fund an unpopular choice among investors. The product lost 32.5% in the year-to-date timeframe. Link to the original post on Zacks.com

Direxion Daily Emerging Markets Bear 3x: Long Run Expected Value Is Zero

Summary Since inception, the ETF has depreciated over 98%. Its long run expected value is zero due to the structural deficiencies of leveraged ETFs, combined with the positive expected return of emerging market equities. The ETF is easy to borrow, making this an actionable short candidate when sized prudently. Background on the Fund The Direxion Daily Emerging Markets Bear 3X ETF (NYSE: EDZ ) seeks daily investment results, before fees and expenses, of 300% of the inverse of the performance of the MSCI Emerging Markets Index. As summarized below, the MSCI Emerging Markets Index is diversified geographically across 23 countries and 837 individual stocks. Source: MSCI Emerging Markets Index Fact Sheet The Direxion fund attempts to create its leveraged exposure through investing at least 80% of its assets in a combination of instruments/derivatives including futures, options, indices, swaps, forwards, reverse repurchase agreements, ETFs, and equity caps, floors and collars. As shown below, the fund is down more than 98% since its inception in late 2008. (click to enlarge) In order to understand the reasons for this performance, as well as whether it’s likely to persist over the long run, it helps to break down the performance into its two key drivers: 1) the return of the underlying index, and 2) the construction of the ETF. Let’s go through each. Performance of Underlying Index Despite the recent turbulence in emerging markets, the MSCI Emerging Markets Index is up just over 8.5% annually since 2000. (click to enlarge) Source: MSCI Emerging Markets Index Fact Sheet As we look forward, predicting short term moves in the market is extremely difficult (or impossible, according to some academics). But we do know that the MSCI EM Index is trading at an average (12 month forward consensus) P/E ratio of about 11, which translates to an earnings yield of about 9% (higher if cyclically adjusted). This means that if we ignore growth and assume that valuation multiples stay constant, the annual return of the index would be in the very high single digits so long as the value created by the underlying companies ultimately accretes to shareholders. (click to enlarge) Source: Yardeni Research Global Index Briefing Construction of ETF The second (and likely more important) driver of returns for the Direxion ETF over longer periods of time is the methodology of its construction. There are numerous articles in the academic literature (such as this ) reviewing the tendency of leveraged ETFs to decay over time. I’ll go through a number of additional examples of this decay a little later on, but first let’s walk through the reasons why it occurs. Effectively short volatility / mean reversion: Since the ETF seeks to track the daily returns of the underlying index, it must rebalance on a daily basis. When the index goes down, the ETF must add short exposure to maintain its positioning, and vice versa when the index goes up. In other words, the ETF routinely needs to “buy high and sell low.” The result is that in volatile, but non-trending markets, the ETF decays. The fund’s prospectus provides an example that “this fund… would be expected to lose 31.3%… if its Index provided no return over a one year period during which the Index experienced annualized volatility of 25%.” Magnified transactions costs: ETFs incur transactions costs when investors move in and out of the funds. The impact of this can be magnified for leveraged ETFs like EDZ since a) a large portion of the underlying investors in these funds are short-term oriented, and b) the funds must rebalance daily based on market moves, as discussed above. Fund expenses: Though not unique to leveraged ETFs, fund expenses are another marginal drag on returns. Per the fund’s prospectus, its operating expense ratio is approximately 0.98%. Additional Examples Below we can see a summary of annualized returns for the various equity-related Direxion 3x leveraged ETF pairs that have track records of at least 2 years. Name Ticker Appx Annualized Return since Inception Daily Energy Bull 3x ERX 0% Daily Energy Bear 3x ERY -47% Daily Financial Bull 3x FAS 14% Daily Financial Bear 3x FAZ -68% Daily Gold Miners Index Bull 3x NUGT -70% Daily Gold Miners Index Bear 3x DUST -12% Daily Junior Gold Miners Index Bull 3x JNUG -81% Daily Junior Gold Miners Index Bear 3x JDST -71% Daily Real Estate Bull 3x DRN 45% Daily Real Estate Bear 3x DRV -59% Daily Semiconductor Bull 3x SOXL 19% Daily Semiconductor Bear 3x SOXS -53% Daily Technology Bull 3x TECL 38% Daily Technology Bear 3x TECS -53% Daily Mid Cap Bull 3x MIDU 25% Daily Mid Cap Bear 3x MIDZ -53% Daily Small Cap Bull 3x TNA 30% Daily Small Cap Bear 3x TZA -60% Daily FTSE China Bull 3x YINN -8% Daily FTSE China Bear 3x YANG -42% Daily Developed Markets Bull 3x DZK 1% Daily Developed Markets Bear 3x DPK -43% Daily Emerging Markets Bull 3x EDC -6% Daily Emerging Markets Bear 3x EDZ -47% Daily Russia Bull 3x RUSL -58% Daily Russia Bear 3x RUSS -30% Simple Average -27% Although all of these ETFs are vulnerable to the sources of decay outlined above, in this article I highlight the Direxion Daily Emerging Markets Bear 3X ETF for a few important reasons: This ETF is easy to borrow (with a cost under 3% through some retail brokers), which makes it worthy of consideration as a longer term short for those knowledgeable in these products. However, a critical caveat is that the position would need to be sized prudently, given that there have been occasions when some of these ETFs have moved more than 100% over relatively short periods of time. Emerging market equities are an especially volatile asset class, which I expect to exacerbate the leverage trap given that these ETFs tend to underperform during periods of volatility, as discussed above. Equities tend to be more mean-reverting (compared to commodities, which often trend). As again reviewed above, these ETFs tend to decay most in mean-reverting environments. Emerging market equities are likely to have one of the highest long run expected returns among asset classes (though not necessarily the highest Sharpe) given their elevated earnings yield noted previously. Conclusion As long as one believes that the long run performance of emerging market equities will be positive or that it will be flat but with non-zero volatility, the long run expected value of this ETF is zero. Those considering trading the ETF should be cognizant of this (and the implicit bet on volatility that they are making).

The Importance Of Emphasizing Quality And Financial Health In Your Stock Holdings

A majority of stock fund managers want corporations to improve their financial health as opposed to rewarding shareholders through buybacks and dividends. Unfortunately, the ability for corporations to service existing debt is at its lowest point since 2009. Companies with the highest-rated financial health have outperformed SPY in 2015, whereas buyback “achieving” corporations have been sliding. According to a recent Bank of America Merrill Lynch survey, a majority of stock fund managers want corporations to improve their financial health as opposed to rewarding shareholders through buybacks and dividends. That has not happened since the earliest stages of the economic recovery. Why are asset managers, myself included, expressing concern about what companies do with their money? They’ve taken on too much debt. They are leveraged to the hilt . In fact, corporations owe more interest on their debt than at any prior point in history. That’s not a problem, you argue. The only thing that matters for “credit-worthy” businesses is their ability to service their obligations. And the Federal Reserve will remain very accommodating for many years to come. Unfortunately, the ability for corporations to service existing debt (a.k.a. “interest coverage”) is at its lowest point since 2009. Imagine that. In spite of a Fed that has kept overnight lending rates near zero for seven years, companies face the same challenge with debt servicing today as they had back in the recession. Worse yet, what is the probable outcome for corporations if Janet Yellen and her Fed colleagues actually hike borrowing costs in the near future? Perhaps you are skeptical about the notion that public corporations might stumble with respect to growing their businesses while paying back existing debts. Then you might want to look at the changing landscape for companies that reward shareholders with stock buybacks. At the start of the current recovery up through the end of last year (12/31/2014), the PowerShares Buyback Achievers Portfolio ETF (NYSEARCA: PKW ) outperformed the SPDR S&P 500 Trust ETF (NYSEARCA: SPY ) by a landslide (i.e., 187% to 125%). Since the start of 2015, however, companies borrowing to buy back their stock shares have lost significant momentum. The declining PKW:SPY price ratio below demonstrates the shift from confidence to concern. Why should corporations that are limiting stock supply and increasing demand through their buybacks see their share underperform? In essence, there’s trepidation that some corporations have borrowed beyond sensible leverage ratios and simultaneously puffed up their earnings in ways that may not reflect organic growth. Keep in mind, business loans as a percentage of GDP are higher now than at August of 2000 and at August of 2007. The use of leverage by households, government, financial companies and non-financial companies was certainly out of control at those moments in history. What’s more, the leverage extremes of the past led to credit cycle and business cycle contractions. It follows that it may be reasonable to assume that credit contraction is likely to occur soon enough. In fact, extremes in the use of leverage tend to downshift at the least opportune times. Fewer borrowed dollars would mean less money for productive purposes (e.g., plants, equipment, human resources, research, etc.) or for immediate investor benefit (e.g., share buybacks, dividend increases, etc.). Some may believe that central bankers are more prepared for a severe pullback in credit today. Perhaps they would turn toward an even larger open-ended quantitative easing (QE) program or implement a policy of negative interest rates. The only problem is, corporate bond issuers are already seeing diminishing benefits of lower yields. The Fed, the Bank of Japan, The European Central Bank may be eager to promote lending at a time when they see a need for more stimulus, but it may not matter if households and corporations are fearful of additional borrowing. It should come as no surprise, then, that companies with the highest-rated financial health have outperformed SPY in 2015. Whereas buyback “achieving” corporations have been sliding via the PKW:SPY price ratio above, the iShares MSCI USA Quality Factor ETF (NYSEARCA: QUAL ):SPY price ratio has been rising throughout the year. Binge borrowing by corporations may not be a death knell for the bull market in stocks. Nevertheless, when one factors earnings declines and revenue declines into diminishing benefits from ultra-low borrowing costs, one may find it less lucrative to buy every dip. Disclosure: Gary Gordon, MS, CFP is the president of Pacific Park Financial, Inc., a Registered Investment Adviser with the SEC. Gary Gordon, Pacific Park Financial, Inc, and/or its clients may hold positions in the ETFs, mutual funds, and/or any investment asset mentioned above. The commentary does not constitute individualized investment advice. The opinions offered herein are not personalized recommendations to buy, sell or hold securities. At times, issuers of exchange-traded products compensate Pacific Park Financial, Inc. or its subsidiaries for advertising at the ETF Expert web site. ETF Expert content is created independently of any advertising relationships.