Quantifying Triple Leverage ETF Performance vs. Target Index (FAS, FAZ, BGU, BGZ, ERX, ERY)

Direxion has issued its semi-annual report for its triple leverage ETF holders and there are some interesting revelations here.  While there are many others covered, we wanted to demonstrate some of the differences among the Direxion Daily Financial Bull 3X Shares (NYSE: FAS), Direxion Daily Financial Bear 3X Shares (NYSE: FAZ), Direxion Daily Large Cap Bull 3X Shares (NYSE: BGU), Direxion Daily Large Cap Bear 3X Shares (NYSE: BGZ), Direxion Daily Energy Bull 3X Shares (NYSE: ERX), and the Direxion Daily Energy Bear 3X Shares (NYSE: ERY).

The report is for the period of November 5, 2008 to April 30, 2009, and it probably wasn’t needed to say it but Direxion noted that the first four months of the period were marked by severe distress in the economy and much more so in the financial sector.  Technically, none of this is new if you have looked at the documents before.  But many investors and traders alike have either chosen to forget or just didn’t do any homework and missed the notion that triple-leverage ETFs do not move tick for tick for the triple-long and triple-short.  What is interesting is that Direxion is essentially spelling out that the returns on these instruments vary and do not necessarily correlate through time with the move of the underlying index.  An excerpt says it all:

• Particularly in periods of heightened volatility, the ETFs should be used by investors as short-term trading vehicles. As a consequence, we do not believe that investors should buy and hold the funds.

It also noted that investors should understand the daily performance and the performance through time and stated again that the triple-leverage ETFs are not suitable for all investors and should be utilized only by sophisticated investors who:

• understand leverage risk,
• understand the consequences of seeking daily leveraged investment results,
• and intend to actively monitor and manage their investments.

Here is just an excerpt of how the more actively traded triple leverage ETFs performed against the target index on a few of these instruments.  These figures seem a bit confusing but these were represented by Direxion in their filing:

Direxion Daily Financial Bull 3X Shares (NYSE: FAS) and the Direxion Daily Financial Bear 3X Shares (NYSE: FAZ) offer 300% and -300% of the return of the Russell 1000 Financial Services Index. For the period, the Target Index returned -23.36%. The FAS shares returned -86.27% and the FAZ shares returned -86.22%. The model indicated an expected return of -87.04% for the FAS shares and an expected return of -85.32% for the FAZ shares.

Direxion Daily Large Cap Bull 3X Shares (NYSE: BGU) and the Direxion Daily Large Cap Bear 3X Shares (NYSE: BGZ) offer 300% and -300% of the return of the Russell 1000 Index. For the period, the Target Index returned -7.37%. The Triple-Bull BGU returned -50.07% and the Triple-Bear BGZ returned -25.82%. The model indicated an expected return of -51.26% for the BGU Shares and an expected return of -23.33% for the BGZ Shares.

Direxion Daily Energy Bull 3X Shares (NYSE: ERX) and the Direxion Daily Energy Bear 3X Shares (NYSE: ERY) offer 300% and -300% of the return of the Russell 1000 Energy Index. For the period, the Target Index returned -9.79%. The Tiple-Bull ERX returned -55.53% and the Triple-Bear ERY returned -50.58%. The model indicated an expected return of -56.33% for the ERX shares and an expected return of -48.88% for the ERY shares.

Despite the accusations and scathing comments we have received after noting that more ETF reverse splits or ETF closures may be coming, this is not meant to discourage the use of ETFs nor the use of leveraged ETFs.  But investors and traders alike need to know how the expected returns compared to a target index will vary from day to day and may even vary much greater through time.

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Direxion’s full semi-annual report is here.

Jon C. Ogg
July 7, 2009