Direxion’s leveraged and inverse ETFs seek daily goals, which means that the returns of the ETFs over time should not be expected to be a multiple or inverse multiple of the cumulative return of the benchmark for a period longer than one day. This piece illustrates how different volatility levels of an ETF’s benchmark can impact the returns of leveraged and inverse ETFs for periods greater than one day.
More Is Not Always Better
During the period of mid-December 2008 through mid-April 2009, the Technology Select Sector Index (IXTTR), the benchmark for the Direxion Daily Technology Bull (TECL) and Bear (TECS) 3X Shares, experienced higher volatility, which affected the ETFs’ returns. Volatility in these graphic examples is a statistical measure of the dispersion of returns for the above market index. Generally, the higher the volatility, the riskier the security and the higher risk to investment.
Although the benchmark gained 6.64% over the holding period, the Bull ETF gained only 9.94%, much less than 3X the benchmark’s return. The Bear ETF lost 45.06%, much more than -3X the benchmark’s return.
Definitions for VIX and IXTTR at end of page. Source: Bloomberg. Date: 12/17/2008 - 4/15/2009. Returns for TECL and TECS are based upon market price (not NAV). For the most recent month-end and standardized performance click here.
Less May Be More
During the period from mid-April 2009 through December 31, 2009, the same benchmark experienced much less volatility than in the previous example.
The benchmark gained 35.18% over the holding period. The Bull ETF gained 157.17%. That’s 51.63 percentage points MORE than 3X the benchmark’s return. The Bear ETF lost 69.82%, which is 35.72 percentage points better than -3X the benchmark’s return.
As nice as it is to see greater than expected returns, you must understand that these compounded returns will increase (for a Bull ETF) your exposure levels, and possibly create an outsized return greater than the 3X level, making your position more sensitive to future market movements. Consider selling your excess gains and managing your investment to a specific exposure level.
Source: Bloomberg. Date: 4/24/2009 - 12/31/2009. Returns for TECL and TECS are based upon market price (not NAV). For the most recent month-end and standardized performance click here.
Volatility – Why Does it Matter?
These leveraged and inverse ETFs seek a return, before fees and expenses, that is 300% or -300% of the return of their benchmark for a single day. The Funds should not be expected to provide 300% or -300%, as applicable, of the benchmark’s performance for a period greater than one trading day.
Due to their daily investment objectives, leveraged and inverse ETFs must rebalance their assets to their stated exposure ratio on a daily basis. This means that their returns over time are the product of a series of daily returns, and not the ETF’s beta multiplied by the cumulative return of the benchmark for periods greater than a day.
This deviation in performance is commonly referred to as compounding. The example above illustrates that high volatility causes a decay of long-term returns for the ETFs, while sustained market trends can result in positive effects on returns.
The Bottom Line
Monitor and Act When Necessary
Daily rebalancing ETFs are not meant to be held unmonitored for long periods. If you intend to hold leveraged and inverse ETFs for periods greater than one day, you must always watch them closely.
- During highly volatile periods for an ETF’s benchmark, you will need to adjust your positions frequently to maintain constant exposure levels.
- During periods of lower volatility for the benchmark, you should continue to monitor, but position adjustments will likely be needed less frequently.
If you don’t have the resources, time or inclination to constantly monitor and manage your positions, leveraged and inverse ETFs are not for you.
Leveraged and Inverse ETFs are not suitable for all investors and should be utilized only by sophisticated investors who understand leverage risk, the consequence of seeking daily leveraged or inverse investment results and intend to actively monitor and manage their investments.
VIX is the ticker symbol and the popular name for the Chicago Board Options Exchange’s CBOE Volatility Index, a popular measure of the stock market’s expectation of volatility based on S&P 500 index options.
IXTTR is the ticker symbol for the Technology Select Sector TR Index, which is provided by S&P Dow Jones Indices and includes domestic companies from the technology sector which includes the following industries: computers and peripherals; software; diversified telecommunications services; communications equipment; semiconductors and semi-conductor equipment; internet software and services; IT services; electronic equipment, instruments and components; wireless telecommunication services; and office electronics.
An investor should consider the investment objectives, risks, charges, and expenses of Direxion Shares carefully before investing. The prospectus and summary prospectus contain this and other information about Direxion Shares. To obtain a prospectus and summary prospectus call 866-476-7523 or visit our website at direxion.com. The prospectus and summary prospectus should be read carefully before investing.
Investing in a Direxion Shares ETF may be more volatile than investing in broadly diversified funds. The use of leverage by a Fund increases the risk to the Fund. The Direxion Shares ETFs are not suitable for all investors and should be utilized only by sophisticated investors who understand leverage risk, consequences of seeking daily leveraged, or daily inverse leveraged, investment results and intend to actively monitor and manage their investment.
Direxion Shares Risks - An investment in each Fund involves risk, including the possible loss of principal. Each Fund is non-diversified and includes risks associated with the Funds’ concentrating their investments in a particular industry, sector, or geographic region which can result in increased volatility. The use of derivatives such as futures contracts and swaps are subject to market risks that may cause their price to fluctuate over time. Risks of each Fund include Effects of Compounding and Market Volatility Risk, Leverage Risk, Market Risk, Counterparty Risk, Rebalancing Risk, Intra-Day Investment Risk, Other Investment Companies (including ETFs) Risk, Cash Transaction Risk, Tax Risk, and risks specific to the Technology Sector. The value of stocks of information technology companies and companies that rely heavily on technology is particularly vulnerable to rapid changes in technology product cycles.
Additional risks include, for the Direxion Daily Technology Bull 3X Shares, Daily Index Correlation Risk, and for the Direxion Daily Technology Bear 3X Shares, Daily Inverse Index Correlation Risk, and risks related to Shorting. Please see the summary and full prospectuses for a more complete description of these and other risks of each Fund.
Distributor: Foreside Fund Services, LLC.