Direxion Changes Mutual Funds to Monthly Leverage

All the leveraged mutual funds offered by Direxion have changed their investment objectives as of the end of September.  Previously, Direxion offered a daily leverage factor of 2.5X, or -2.5X in the case of inverse mutual funds.   Now it will be 2X or -2X.  More important, the basis for the leverage will be monthly rather than daily.  Additional information can be found on the Direxion website.

We’ve talked before about the perceived problems of daily reset for leveraged funds.  In fact, these funds have almost always performed exactly like they are supposed to perform.  The problem is that people do not understand them.  Sponsors like Direxion, ProShares, and Rydex have done their best to educate people, but some still don’t get it.  The result is lawsuits and a regulatory crackdown.

Direxion is obviously trying to address this concern by changing the way their leveraged mutual funds work.  This may be effective in terms of marketing strategy, but I’m not sure it will make regulators or lawyers any happier.  All Direxion is doing is exchanging one set of problems for another.

First, moving the leverage reset from daily to monthly will not stop the mathematical decay of these funds.  At best, the decay will slow down.  People will still see a mismatch when they look at long-term performance.

Second, one-month spans are far more likely to contain big moves than one-day spans.  This is important because a fund that is 2X or -2X leveraged will, in theory, be wiped out by a 50% move in the opposite direction.  A one-day move of 50% is unlikely in the indexes tracked by Direxion.  A 50% swing within a one-month period is also unlikely, but the potential is still much higher.

Third – and probably most important – anyone who buys one of these funds in the middle of a month will not know what leverage factor they are getting.  It could be 2X, 1.5X, 3X, or anywhere in between.  This will force long-term investors to bunch their transactions around month-end and probably mean less volume the rest of the month. 

Having said all this, I am glad to see Direxion innovating in their product design.  The truth is we will probably never get a “perfect” ETF that works for everyone.  Investors all have their own objectives.  Sponsors are all trying to find their niche.  Has Direxion hit on something that will work?  Only time will tell.